Why Lenders Use Credit Scores

June 29, 2011 by  Filed under: Credit 

Why exactly is bad credit bad? What is it about a low credit score that makes lenders turn you down? Looking at the lending business from a bank’s perspective can help you understand why your bad credit gets you turned down.

How Banks Make Money

Banks make money by earning interest on money they loan to others – individuals, businesses, other banks, and even the government. The longer you take to pay back your money, the more interest the bank earns. Similarly, the higher your interest rate, the more money the bank earns. Like most businesses, banks want to earn as much money as possible.

Credit History Helps Decide the Best Borrowers

Before a bank loans you money, either through a loan or by giving you a credit line, they want to be sure you’ll pay it back. It’d be great for consumers if your promise to repay were good enough. You could borrow as much money as you wanted until the bank ran out of money to loan. But, there are a great number of people who would never pay back their loan or they’d pay it back at their own convenience. The bank loses money on these types of accounts and they’d soon be forced to go out of business.

The bank only wants to loan money to people who are actually going to repay their money. One of the ways they judge who’s going to pay back and who won’t is by looking at who’s paid their bills in the past. In other words, they look at your credit report, which contains a list of your previous accounts and your payment history with those accounts. If you’ve had a lot of late payments or accounts that have defaulted, the bank knows there’s a chance you won’t pay back their loan and that they’d lose money on your account. So, they may decline the chance to loan money to you. Or, they’d charge a high interest rate, which would let get back the money they loaned faster.

Banks don’t have time to review every applicant’s credit report line by line to figure out whether who might default and who would pay on time. Instead, they use your credit score, a number that summarizes the information in your credit report, to approve your loan application faster. Credit scores allow banks to give you instant approval because they have a certain credit score cutoff that they consider. Some banks have a “gray area” of credit scores. If your credit score falls in this area, the lender may manually review your credit score to make a decision about you.

Proving Yourself to Be a Worthy Borrower

This is why credit repair is so important. Lenders are judging you based on what you’ve done in the past. You may have changed your spending habits, started paying your bills on time, but if your credit history says that you miss payments and default on your accounts, banks won’t want to give you a loan. The solution is to have your credit report reflect your new credit habits by getting negative information removed from your credit report and having positive information added. If you don’t know how to do this on your own, consider hiring a credit repair company to help you improve your credit score.

Steve Dowell is a seasoned writer in finance, specializing in credit repair. You can find more of his articles located at CreditRepair.org.

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