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How Credit Score Work?



All the banking business is about money. However, the banking business is really all about information. Until banks have the required information about a prospective borrower, they cannot ascertain the risk and make the loan. This is where credit rating comes to the rescue. Let’s have a closer look at how the process of credit rating works!

 

 The Need for Credit Score

In order for the banks to be able to make loans to different borrower, they must have information about the credibility of these borrowers. The information they require is firstly regarding the intent of the borrower to pay back the loan and secondly regarding the ability of the borrower to do so. The ability can be gauged partially from the income of the borrower. In order to completely understand the borrower’s ability to pay back the loan, banks need to know if the borrower currently has any other loans outstanding. Also, the borrower’s previous repayment records provide considerable information regarding his/her intent to pay back the loans. Therefore, in the absence of any organized way to collect information about prospective borrowers, the banks would have no way to make loans to anyone apart from a handful of people whose records they already have. Therefore, there is a need for an agency that aggregates information from all the various banks and financial institutions and provides it back to the banks.


The Idea of Credit Score

Credit rating companies perform precisely the above mentioned task. They do not work for any individual bank. Rather the agency is formed by the co-operation of all the banks in the banking system. Every member bank provides data regarding the loans and repayments of its customers. This data is then sorted based on the unique identification provided by the customer such as Identity card number and name. Therefore if an individual borrows from multiple banks, the information regarding these multiple loans is available in a centralized repository and can be accessed by member banks for a fee.

The basic idea is that the reach of the banking system as a whole is huge. Therefore, an individual bank may not have enough information about a prospective borrower. However, if information from multiple banks is pooled, odds are that there will be enough information available to make an informed decision.


Credit Score is Not a Measure of Wealth

It is easy to get confused regarding what exactly is measured by credit scores. Credit scores do not monitor the wealth of individuals. 

Instead, credit scores represent the timeliness with which a person pays their bills. Therefore, if late on paying the bills, they may have a lower credit rating than a middle class person who always pays bills on time.


• Major Credit Score Agencies

Banks conduct a credit check on anyone that applies for a loan. This credit check entails querying of the past payment records in order to find out if there are any missed payments or loans defaulted upon. There are three major agencies that have the technology to enable banks to check credit almost instantaneously. These agencies are CBM, CTOS, Expedia


• How are Credit Scores calculated?

Different credit agencies have their different formulas to evaluate every individual’s credit score. You should not assume that your credit score will be the same across these credit agencies. Credit scores vary for two main reasons, the data on which the score is based, and the method of calculating the score. In general, here are the factors considered in credit scoring calculations.

 

→ The number of credit facilities and the amount owed to the banks

→ Whether you pay your loans on time or have missed payments in the past

→ Your credit history length

→ Types of secured and unsecured credit you hold – secured (home, car loans) vs unsecured credit (credit cards, personal loans)

→ Have you been approved for new credit facilities recently

 

However, having a good credit score can be extremely beneficial for you, as most banks and credit providers would view you as a prime customer. A good credit score can increase your chances of getting a loan, get you better interest rates and speedier loan approval, among other things.





















Kepong

Kuchai Lama