We all know that credit scores have been a major factor for many people in the past and present. However, this article is about to show you that there is one factor that catapulted it from being a simple number to a highly-important piece of information: loan rates.
How Credit Scores Came to Be
In the mid-1960s, a group of researchers from Harvard University was looking into how banks were setting interest rates based on credit scores. The result of their research was that for people with a “good” credit score, banks would give them higher interest rates than people with a “bad” credit score. These findings led to the creation of credit scoring systems and greatly impacted how lenders decided who to give loans to.
In the United States, a credit score is a number that lenders use to determine how likely it is for someone to repay a loan. It might seem like an odd thing to have in the first place, but it’s actually pretty simple why the system exists. The idea came from another common method of gauging risk, called the “credit rating.”
Overview of the Credit Scoring System
The credit scoring system is designed to predict how likely a consumer will be to repay a loan. This credit score gives lenders an idea of how much risk they are taking by extending credit. If the bank extended $2,000 on a consumer with an 800 credit score, it would take that consumer only $0.02 in interest for each day that he or she received the loan.
The credit scoring system is a complicated mathematical formula that helps lenders decide whether or not to approve a loan for a consumer. The system combines information about the consumer and their financial history into one number that lenders can use to make judgments about how safe it would be to lend money. Lenders also use this number to determine interest rates on loans.
The Impact of Loans on Credit Scores
When you apply for a loan, your credit score is impacted. The fact that you’re applying for a loan means that you are trying to borrow more money than what you have available in your bank account. When your score drops, it becomes harder for you to find new loans or credit cards with low interest rates.
A loan will affect your credit score in two ways: 1) the interest rate on the loan and 2) the length of time that you have access to the funds. The longer you have a loan, the more likely it is that you will pay back less than what was borrowed.
The Unexpected Role of Loan Rates in Credit Score Calculations
Loan rates are often disregarded as a factor in determining a credit score. However, the loan rate used to calculate the credit score only represents about 15% of the overall rating. The other factors used for calculating the credit score include payment history, number of revolving accounts and length of credit history.
When a borrower applies for a loan, the lender will use their credit score in order to determine what interest rate they would offer that person. In addition, the point at which you reach your credit score’s maximum will also be decided on by the lender. A higher point value is often linked to a lower interest rate, which could affect whether or not you get approved for that loan.
This is a blog about credit score and loan rates. The conclusion of the blog is that there is no excuse for not obtaining a credit score. The reader should get their credit score from a lender to see where they stand before taking on any serious debt.
The same basic facts apply to all credit scores. The lower the score, the more likely you are to drop interest rates on loans and have a harder time getting approved for loans. Conversely, your rates are likely to go up when you have a higher credit score.