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What Is Bad Credit?

Credit - The right granted by a creditor to pay in the future in order to buy or borrow in the present.

Credit-scoring (how credit rating score is obtained) - A method, based on statistical analysis of applicant characteristics, through which lenders determine the applicant's qualification for credit.

Many creditors use a credit rating score to help determine whether or not to grant credit to an applicant. The lender relies upon credit bureaus to supply them with these credit scores, as explained later. The 3 credit report agencies primarily used are Trans Union, Equifax, and Experian credit report agency (formerly TRW.) According to the Federal Trade Commission Site on Consumer Issues , the credit-scoring characteristics include an applicant's bill-paying history, the number and types of accounts she/he has, the age of the accounts, and outstanding debt. Generally, someone with a good credit rating score is said to have good credit. The lender does not see just a score and judge applicants based on the score number alone, however. They consider all the characteristics, as discussed below.

Many creditors rely on the three "C" factors of credit when deciding whether to grant credit for mortgages, mortgage refinancing, personal loans, student loans, and other loans. They consider the applicant's capacity, capital, and character. As it turns out, the credit scores are based on these three factors anyway. Therefore, an explanation of the three "C" factors will also explain the factors that go into a credit score. Someone who has good capacity, capital, and character has good credit / a good credit rating score.

Capacity - Your ability to make payments on time for as long as you owe money. The amount of time you have held a steady job, your salary, and the amounts you owe to other creditors all have an impact on this decision. Those who are unemployed every six months or work at minimum-wage jobs are usually considered to have poor capacity. Those who have been consistently employed for five years and have only two small student loans to repay are usually considered to have a good capacity for credit. On the other hand, if the applicant is already repaying four big personal loans, she/he may not be able to obtain another one.

Capital - The money in your bank accounts as well as the value of your stocks, your boat, and your house are considered capital. Most creditors like to know you have the ability to repay the loan through the sale of an asset in case you become unable to work and run out of savings. Usually the more capital applicants have, the bigger the personal loans or mortgages they can obtain. (Unless you have a lot of loans repay.)

Character - How good (or bad) you are at keeping your promises. In other words, your willingness to make payments for the right amount at the right time, all the time. When I worked for a mortgage company, I saw applications of people who met the requirements of the other Cs but not this one. For example, a wife and husband each made three-figure salaries (capacity) and had tremendous 401-K accounts and savings (capital). However, they had missed payments for credit cards one month, were two weeks late paying student loans another month, etc. They passed the first two tests easily, but they flunked the third. They did not obtain the mortgage for the house for sale they had in mind.

How are these three Cs obtained? The information is obtained from both the borrower's application form and from credit reports issued by credit bureaus. Every time you pay a bill—whether it's on time, late, or not paid at all—the transaction is recorded on a credit report. This report will show how your monthly car loan payments, mortgage, rent, utility payments, etc. By the way, credit scores are also based upon information in the application form and in credit reports.

What is good credit or a good credit rating score? That is the question I asked when I called three helpful mortgages consultants. One was with a small community credit union, another was with a national mortgage company, and the third worked for the mortgage branch of a national real estate listings company. Ivern of the credit union stated that she and the other credit union lenders ignore credit scores and use only the "Three Cs" when deciding upon whether to grant mortgage refinancing or mortgages. She stated an important consideration is the applicant's income-to-debt ratio, (which falls under "Capacity".) Ivern explained that the ratio should be no worse than 60:40. In other words, at least 60 percent of the applicant's income should be available to pay for living expenses, such as groceries. No more than 40 percent of the applicant's income should be taken up paying off debt, such as auto loans and credit cards bills. That 40 percent also includes repayment of the loan being applied for. Another important determinant is credit history, such as whether an applicant has filed for personal bankruptcy or whether the applicant pays bills on time.

It appears that large lending companies more often rely on a credit rating score to help make loan decisions. Craig of the national mortgage company explained that consultants at his company base their lending decision upon one of three scores. He explained, "We obtain one score each from Equifax, Experian, and Trans Union. We ignore the highest and lowest scores and rely upon the middle score." (It sounds similar to the scoring system at the Olympics.) He continued, "Most people are between 500 at worst and 850 at best. Anything over 680 is good—[they will have] no trouble getting a loan here. Some places [consider "good" to be] as low as 620. Over 700 is considered excellent."

Like Ivern, John K. of the large real estate company stated that he and others in his department consider the applicant's income-to-debt ratio. However, like Craig, he said they rely upon an applicant's credit rating score. He stated that scores of 680 and over are "average to above average" and that such applicants should be able to find the lowest mortgage rates, assuming they do not have too much debt. "But scores below 680 are deemed below average. " The lower the score, the harder it will be for applicants to find loans at fairly low interest rates. (Usually lenders want to be compensated for granting "high risk" loans and so charge higher mortgage interest rates.) John K. explained that his company also obtains scores from the big 3 credit report agencies: Equifax, Experian, and Trans Union. The consultants take the average of the three scores and use that average in making the loan decision. The credit scores are useful because they are based upon a combination of factors, such as whether a person makes payments on time every month and how much income a person is using to pay off debt on credit cards, student loans, and auto loans.

Consultants also look at the two types of debt most applicants have: installment debt and revolving debt. An auto loan is an example of installment debt. The amount of the loan is fixed, and the debtor pays the same amount each month. Credit card balances represent revolving debt. The amount debtors pay each month often varies, and the balances usually change continually. Revolving credit cards debt is limited only by the spending limit of each credit card. A person who has five cards with $7,000 spending limits has the potential of owing $35,000 plus interest. There was no need to ask which type of loans lenders would prefer to see.

For a further explanation of the credit rating score process, I consulted the credit scoring information page at the Federal Trade Commission Site on Consumer Issues. According to the FTC site: This information is collected from the credit application and credit report. Points are awarded for each factor that determines who is most likely to repay a debt. The total number of awarded points results in the credit score, and it helps tell lenders how creditworthy you are. Creditworthy means the likelihood of your paying back the loan and making the payments on time. Certain factors are given more weight than others. For example, one's history of paying—or not paying—credit cards bills, utility bills, personal loans, student loans, etc. on time is usually given much weight. Also, the applicant's ratio of debt to his/her credit limit is strongly considered. (For example, someone who makes $50,000 per year but is paying debts of $20,000 per year is probably greatly exceeding his/her credit limit.) The length of time one has had credit also plays a significant role, since it shows how well the person handles credit over long periods of time. Because the credit report plays an integral role in many credit rating score systems, people should make sure the reports are accurate before they submit a credit application.

Credit scoring is usually more reliable than judgmental means, since it is based on real data and statistics, and every credit reporting agency must follow governmental guidelines when forming their credit scoring systems. I think it's also worthwhile to check the Internet for sites offering a free credit report.

How do I get good credit/a good credit score? From my experience with a mortgage company, I can provide a little advice. When you are writing checks to pay bills, make sure you make them out for the correct amount, sign them, and mail them in time for them to be received before the due date. I've seen mortgage applicants turned down because applicants were sloppy in writing checks and/or because they mailed the checks on the due date instead of before it. Therefore, their payments arrived late, were made for incorrect amounts, or were not signed. All these errors resulted in late payments and were duly recorded on the credit report. Anyone can make a mistake once, but people who repeat their mistakes are not usually regarded as reliable.

If you have bad credit personal loans, bad credit auto loans, other bad credit loans or past bankruptcy, please do not worry needlessly. There are still many lenders who are ready to grant you loans at the lowest rates possible. They often have online mortgage calculators and other beneficial features. To save time and trouble locating them, it may be a good idea to start your search for many lenders dealing in auto loans, personal loans, mortgage refinancing, and other bad credit loans right here at Bad Credit Alliance, !

For more information about good credit and credit repair, I went straight to the Federal Government (again). According to a Federal Reserve Bank of Philadelphia Consumer Resources article, it is essential to protect credit to achieve good credit standing. That means:

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Safeguarding credit, debit, and ATM cards, as well as account and personal identification numbers (PIN). Carry only the cards you expect to use and keep the others in a safe place.
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Maintaining a list of account and telephone numbers of issuers of the credit cards. Then, if the cards are lost or stolen, you can notify them right away, before someone runs up huge bills. The credit card companies won't charge anything if you tell them to cancel the accounts before someone uses them. After someone uses them, you will be liable for $50 per card.
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Check your credit card bills carefully to detect errors. If you want to dispute a charge, you must tell the creditor in writing within 60 days of receiving the bill. Include your name, account number, and the reason you are disputing it. (The lesson is to never just ignore the charge and not pay it, or your credit will be tarnished).
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Make sure that your credit reports are accurate. (As previously mentioned, order a report in order to check it for accuracy).

I hope this article has helped clarify the meaning of good credit and a good credit rating score. It probably has also raised a lot of questions. That's good. In that case, please refer to the sources I have referenced as well as other consumer reports. An informed consumer is a wise consumer—and borrower. To obtain more information about credit, please check your telephone book or go online here for consumer credit counseling services.

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