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The word “credit” has many meanings. Credit as we apply it in this definition means that a lender or “creditor” may lend you money to purchase what you wish. You get a “credit line”, or a specified amount of money available to you at will. You can spend up to the limit without penalty, and you can make monthly payments with interest applied, to repay the loan.

Your “credit report” tells the lender how much risk he is taking by lending to you. He will apply the lowest interest rate for a high score, a higher interest rate for good and fair “credit scores”, and may not lend to you at all if you have a “poor” credit score. There are lenders available that will lend to someone with poor credit, and the interest rate or rate of at risk consumers are reflected in the higher interest rate.

What most people don’t take into account is how much of their lives are caught up in “credit”. We buy a car, and make payments. We buy a house and make payments. We have as many credit cards as we can get to buy the other things we want. Most of the time we do not take into account the accumulation of these promises on our ability to repay the debts. Most of us suffer from raging optimism about our abilities to repay, or don’t think about it at all. We assume our jobs will not be lost, nobody in our family will pass away, and we will always be able to feed our kids. As everyday life occurs, however, most of us find that we have overestimated our continuing ability to pay our debts. We start robbing Peter to pay Paul…not a good thing.

What most people don’t take into account is how much of their lives are caught up in “credit”. We buy a car, and make payments. We buy a house and make payments. We have as many credit cards as we can get to buy the other things we want. Most of the time we do not take into account the accumulation of these promises on our ability to repay the debts. Most of us suffer from raging optimism about our abilities to repay, or don’t think about it at all. We assume our jobs will not be lost, nobody in our family will pass away, and we will always be able to feed our kids. As everyday life occurs, however, most of us find that we have overestimated our continuing ability to pay our debts. We start robbing Peter to pay Paul…not a good thing.

In no time, our credit reports and credit scores downgrade our “risk factor” that lenders see, and it becomes even more difficult to get new credit.

The three credit reporting agencies, Experian, Trans Union and Equifax use a subjective set of algorithems to decide what category your current status related to income and expenses puts you into:  Excellent, Good, Fair, Poor, and Bad.  Every few years, the bureaus adjust the range of each to the changing market.  Currently, scores range between 350 and 850.  It takes above 720-740 to get the best interest rates.

Let’s look at an example of the scoring system in action.  You might go shopping to purchase a used car.  You find one for $15,000, and you do not have the cash to purchase it outright.  Therefore, you need a loan.  You can get a loan if your score is high enough, but the interest rate you will pay is dependent upon your score.  Hypothetically, you have a 750 or higher score.  You may qualify for no down and 0% interest at some dealers.  You have a 650 or higher, and you might qualify for 3%.  If you have a 600 score, you will pay at least 7%, and depending upon the “dings” in your credit, it might be higher.  If you have a 550 score or lower, you may not qualify, or you may qualify for as high as 30% interest.  Yes, 30% interest.  And they will usually want a healthy down payment as well to minimize their risk.

So what does risk mean?  Risk means that the lender in the above situation, whether he is the dealership, the car manufacturer, a credit union or other bank lender, or private lender…all look at the risk they are taking to lend to you.  Risk literally gauges whether or not the lender thinks you will “default” on the loan…that means stop making payments.  The higher the risk, the more chance he is taking to lend to you.  The same goes for a home, a motorcycle, a ski-doo, or any other recreational vehicle, furniture, carpeting…you name it.there’s usually a lender for it.  They all look at risk in this same way.

So it is important for you to have as high a score as possible before trying to purchase something.  So now you want to know…what makes up my score?

Using the most revered of the scoring models, FICO, 35% of your score is made up of your “payment history”…over time, how many times have you been late with payments, especially in the last two years before purchase.  The more times you have been late the lower your score.

30% of your score is based upon how much you owe.  This brings up the “_ratio”…literally how much credit do you have, and how much have you used.  Let’s look an example of a typical person’s credit-ability:  you have a $3000 credit card for your pets, teeth, etc.  You have a $2500 credit limit on a Visa Card, and a $5,000 on a Master Card.  You have total of 10,500 in available credit.  You have spent $2000 of that on purchases, and you are making payments.  Your debt to credit ratio is $2,000 divided by $10,500 which equals 19% debt ratio.  You are golden!  In another scenario, let’s say collectively you have spent $7,500 of your credit-ability.  Your debt ratio is $7500 divided by $10,500 or $71% debt ratio.  Now you are in trouble.  The bureaus review these numbers.  If you spent over 30% of your credit limit on a per-card basis, your credit score is severely impacted, anywhere from 50-100 points.

15% of your score is based upon the length of your credit history.  For instance, a 25 year old just starting out with a 7 year history may be scored lower than his parent at 50 years old with a 32 year history.

10% of your score is based upon new credit…in other words, will someone lend to you at your current ratio?

10% of your score is based upon the types of credit you have.  For instance, a home loan, a car (installment) loan, and credit cards are three of the types of credit you may have.  The more diverse, the better the score.  For instance, if you have only credit card debt and no installments or home, your score is impacted by that fact.

Put them all together, and you can see clearly that careful planning must go in to what types of loans you have and how you pay your bills.

Send contact form or call a specialist 800-610-3440 today!

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