Relation Between Credit Score And Loans

To get an approval for mortgages or car loans or any other type of financing

, you might assume that having a steady job and an income to make the payments is all you need. That is not true. To get an approval for loans you also need a good credit score. A credit score is a number typically ranging between 300 and 800 that represents an individual's trustworthiness in paying his debts. It is nowadays virtually an important factor behind whether or not a loan will be issued and if approved on what interest rate and for what term. So it is extremely important to monitor and manage your credit score. To do so, lets understand the anatomy of a credit score.

The exact formula used to calculate credit scores are closely guarded and every bureau and organization that deals with credit uses its own equation. Besides several other credit variables the five most common components that are used to equate are as follows:-

Firstly your payment history counts for almost 35 % of your score. Payment history measures your on-time payments for consistency. Conversely, a missed payment will plague your credit report and can cause your scores to drop immediately and would signal financial distress.

The second most important credit factor that takes almost 30% of your credit score pie is credit utilization ratio. Credit utilization is the percentage of available credit that is being used. If all of your accounts are maxed out, you will be considered a poor credit risk, because it appears that you are struggling to pay off the debt you have already incurred.

Third is the length of credit history which accounts for about 15%. This usually starts on or near the date that a person opens their first credit card, loan, or other credit account. The longer you maintain accounts in good standing, the better your score will be. This shows that you are able to make a long-term commitment to a creditor and are consistently responsible about making your payments.

Fourth is the type of credit used which counts for 10% and should be a good mix of credit accounts like credit cards, mortgage, car loans and other loan accounts. Having too much of one type of credit can have a negative impact as credit bureaus don't think this accurately represents a person's ability to promptly pay all types of loans.

Fifth is the number of new credit applications you have recently completed, which accounts for about 10% of your score. Applying for too much new credit in a short time period indicates that you could be a credit risk.

Understanding these components that affect your loan and credit score may help you to be more watchful of your credit worthiness.

So how much does your credit score affect your ability to get a personal loan? Before that let us understand that personal loans help to meet short term needs like renovation or vacation etc. and are broadly classified as secured and unsecured loan. Secured loans require collateral and you get to pay a low rate of interest and small amount of monthly payments. Secured loans offer flexible repayment terms. In contrast, you dont need to offer your property as a security if you are opting for an unsecured personal loan. As there is no fixed asset securing repayments, unsecured loans are usually only approved for applicants who are in secure and stable employment and have a good credit rating. The bottom line is that there is a correlation between your credit score and your qualification to a personal loan and it plays a major role in getting a favorable interest rate and term.

As you evaluate your credit score towards your loan, it is equally important to take this critical decision with the right people who will help you to understand better and save more.

by: Ask Bill

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