Why Do We Have Credit Scores?
Before moving onto understanding a credit score or a credit report, it is important to understand why we have these in the first place. Credit, or loans in general, are approved based on an individual / entity’s ability to repay that loan along with interest, if we’re talking about traditional banking / lending. So given that it is based on a person’s ability they have to see what they’ve done in the past. Obviously it is impossible to predict the future with a 100% certainty – so past records provide necessary evidence / information that helps in assessing / predicting the future.
What Is A Credit Report
A credit report usually provides a credit score that is based on the individual / entity’s credit history. I.e. reporting information on (a) whether the loan that was taken was paid back in full (or in part) and (b) when it was paid back (on time, late, early, etc). Typically, negative information in a credit report remains in there for about 7 years, with some information remaining for longer. Active, positive information can remain in a report forever.
Factors Contributing To Your Credit Score
Factors that tend to contribute towards a negative credit score or credit report include late payments, write offs (charge offs) – these are cases of creditors ‘writing off’ their debts because they think it is very unlikely for them to recover the amount(s). Other factors include repossessions of borrowed purchases / assets, as well as foreclosures. Arguably the most significantly adverse impact is that of a bankruptcy – in some cases, these can continue to be reported for 10 years. The same applies to tax liens which are legal impositions on properties in order to secure the payments of taxes.
The terminology used in a credit report is typically standardized throughout. This ensures clarity to the reader when viewing a given credit report or credit score. Moreover it ensures consistency and comparability of a given individual’s credit history, meaning the score can be interpreted in a true and fair manner.
If for instance a borrower has taken a loan against a collateral, and the borrower fails to pay the loan and/or the interest associated with it, then the borrower obviously has the right to claim the collateral’s ownership and this will also be reported in the credit report whilst adversely affecting the credit score.
Credit agencies use risk scoring models that quantify qualitative information about a given individual / entity’s credit history and then convert that to one number which can then be seen as a simplified summary of the entire credit history. Post recession, the number of unsecured credit /loans – these are loans offered without any collateral and typically based solely on the borrower’s word and a signed contract – being offered have fallen considerably.