Why Lenders Check Credit Scores While Processing a Loan Application?

Use of Credit Score

If you have ever borrowed money from a lender, or considered borrowing money, chancesare you have heard about credit scores.

Whether you are buying your next home, a new computer or a car – you may need a loan. Credit scores may also be used by mobile phones, electricity, gas or water providers.
Understanding what credit scores mean, and how lenders use them, may improve your chances of getting your loan approved. It can also help you negotiate a loan with the lender or your bank.

Credit scores allow lenders to decide if they should give you credit, lend money to you, and if yes – how much available credit you should have as a borrower. In simple terms, lenders use credit scores to decide if you are trustworthy and lending you money is worth the risk.
Additionally, all lenders and credit providers must comply with the responsible lending obligation. It applies to new loans and even increases in loans. The person applying for a loan must meet the requirements and have the capacity to repay the loan
without experiencing financial hardships to get approval.

Credit Score For Assessment Results

Many people get upset if the lender doesn’t approve it their loan. Learning why lenders use credit scores can help you understand that it is not just about the risk that lenders are taking. Using credit scores makes the assessment results fair, objective, and consistent.

This kind of assessment benefits you as well that as it protects you from getting a loan that you will not be able to pay on time which will make it even harder for you in the long term.

Apart from using credit scores, lenders may additionally have their own lending criteria, different algorithms, and policies. They may look at your current income, expenses, and savings to assess if you can afford to repay the loan. They may then decline the loan even if your credit scores are high. The fact that different lenders use means that even if you’re refused by one creditor, another one may decide that your ability to repay the loan is good enough and will approve your application.

Certain factors, such a home repossession or bankruptcy, will obviously affect your credit score negatively.

What does your credit score mean?

A credit score is simply a number between 0 and 1200 or 0 and 1000 that is calculated by a credit bureau to determine your creditworthiness. The credit bureau uses information from your credit report to calculate your credit score.

This number changes as your financial habits and your financial situation changes. It is not stored in your credit report. It is calculated every time a credit provider or lender requests your credit report.

The higher the number is positioned on a five-point scale – from excellent to below average – the better your chance of having your loan or credit approved. Understandably, the lenders are more likely to lend money to someone who has a very good or excellent credit score than to a person whose credit score is very low. There is usually a good reason why the credit score is below average, and the lenders consider that as a warning that the risk is too high.

In a nutshell, high credit scores that you have the capacity to repay the loan on time, and low scores show the risk (that is why credit scores are called risk scores as well). A score of over 800 is excellent. It means that you have built a positive credit through paying
your loans and bills on time or limited your lines of credit applying for a loan only when you really had to.

A credit score between 700 and 799 is quite good, and unless something else works against you – there is a good chance that you may get that loan that you apply for. Many lenders will look favorably at the credit score between 500 and 699 although it is average. The approval will depend on other factors, for example, what type of loan you are applying for, what amount, and more.

Below average, which is a credit score below 500, will most likely make getting a loan or a credit quite difficult. But it is not all bad news. If you pay your bills on time and manage your credit commitments, your credit score will improve in no time and your chances of being
approved will increase.

Equifax, one of the biggest credit reporting agencies, uses a 0 to 1200 scale

    If your score is 833 – 1,200 it is excellent. Only 20% of Australian score that, and they are the consumers with the best chance of getting a loan.

    Very Good is 726 – 832, most likely no worries about being approved either.

    Good 622 – 725– try to improve it and make sure it doesn’t get any lower.

    Average 510 – 621 – getting a loan or having your credit extended may be tricky but not impossible.

    Below Average 0 – 509 – it could be a good idea to take steps to improve your score before applying for any loans.

One of the best strategies is to make sure that you understand how and why lenders use credit scores and keep an eye on all the elements of your credit history that most affect your
credit score.

Until recently, the information used to calculate your credit score included

    Details of your current debts, including debts by two months or more

    Loans that you applied for in the last five years

    Your current credits and credit cards

Some Recent Changes

The recent changes give the lenders access to more detailed information to your credit history and a better understanding of your financial habits and your commitment to improving your finances. More information is being fed into the system for lenders and credit providers to use.

These changes mean that the credit providers will see now that you have multiple credit cards that you use for impulse purchases – and that you have a problem paying them on time. Not good!

Lenders may use this information to give better interest and fees to people who have a better credit history and charge people with bad credit with higher interest and fees (risk premium).

That is why it is important to take the necessary steps to improve your credit score and keep it high.