FICO Credit Score and Interest Charges
The benefit of having a good FICO credit score is not about the chances of getting a loan since with bad credit you still have a chance to get a loan. But most importantly, the better the score the lower is the interest charged on the loan.
According to myfico.com, the difference in interest charges between a person who has a score of 500 and other with a 720 score is 4.54 percentage points. This means, on a $ 100,000, 30-year mortgage, you could pay an extra $117,152 in interest charges. Or, in monthly payment, the difference would be $326. Remember, this potential saving is only for one loan.
What is a Credit Score?
Credit score is a number generated by a formula based on information on your credit report compared to the credit performance of others with similar profiles. In this scoring system, a total number of points predicts how likely you are paying your bills when they due -- your creditworthiness.
For loan application approvals, credit rating is more objective than judgmental methods because it's based on real and empirical data of millions applicants. This objectivity supports the Equal Credit Opportunity Act (ECOA) that doesn't allow lenders to predict a borrower's risks based on factors, such as race, sex, marital status, national origin, or religion.
FICO Credit Scoring Systems
Fair Isaac Corporation was the first company that developed a credit scoring system -- a system of assigning value to your credit standing. The score was named the FICO score. It has scoring scale ranges from 300 to 850, where about 85 percent of people in the U.S. have scores between 600 and 800.
Today the FICO credit score is the most widely used credit scoring system and becomes the standard score used by the three major credit bureaus -- Equifax, Experian and TransUnion.
Those credit reporting agencies have their own system for calculating credit rating. Even though all the three scores are developed by Fair Isaac Corporation, there are slightly differences at the three credit bureaus. If your information were identical at all the three bureaus, however, your scores from all the three would be within a few points of each other.
How Lenders Evaluate Your FICO Score
When you apply for a loan, your lender would request to access your credit rating from any of the three credit bureaus. The lender then evaluates your credit reports and scores to make loan and interest rate decisions. The rate you received from the lender will be directly related to your credit rating. The higher your number means the lower interest rate you'll be charged.
When a lender receives your FICO score from a bureau, up to four score reasons are given. If the lender rejects your loan application, these score reasons can help the lender tell you why your score wasn't higher. These reasons are more useful than the score itself in helping you determine whether your credit report might contain errors.
So, understanding your FICO credit rating long before you apply for a loan can help you take steps to fix your credit and save you from unnecessary interest charges. From the above calculation you have seen that being careless with your credit might result in ten thousands of potential loss.
