Individuals with low credit scores generally have the misconception obtaining loans or other types of financing is difficult.
However, if you think bad credit scores can become a barrier for not approving an application for a loan, you are wrong.
There are specific ways, which you can get approved, repay your credit, and be in a financially stable level. In this article, you will find many useful tips to understand the basics of scoring methods and what you can do to improve it.
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What is a credit score, and why is it important?
In today’s competitive banking and financial sector, the applications of loans and other borrowings have different terms and conditions depending on what type of borrowing you want to make.
To avoid the possibility of default the financial institutions use various techniques to identify whether or not the creditor is financially viable. The score determines how risky would it be to deal with a particular borrower in terms of the loans going into default. In other words, it measures and provides information about their creditworthiness.
For that reason, many credit scoring methods were founded to help banks and other institutions to acquire financial stability. Shortly, credit scores are the tools that financial institutions use to foresee how likely you are to repay the disbursed amount.
Think of it as your school transcript where instead of grades, you get your score range. This range is generated each time the bank or other financial institution requests for the general process of their risk assessment and lending.
What is a good credit score, and how is it calculated?
In the United States, there are 2 commonly used credit scoring methods, which are FICO and VantageScore. The process of credit score calculation includes many variables that are extremely important for a bank or credit organization in deciding whether or not to lend money.
VantageScore, for example, has 6 main categories in their model for calculation of consumers’ credit score; however, each of them has different weights for the final score.
We've categorized this list of the criteria from most essential to the least influential ones:
- 40%: Payment history - For both of the scoring methods, your payment history is the most critical factor. Here the financial institution looks through whether you have been making your credit payments on time. This way, they mitigate the risk of having overdue days for principal and interest payments.
- 21%: Age and type of credit - Basically, this is how you manage to pay off multiple debts of different maturity dates. Let’s say you have a 30-year mortgage and 10-year car loan if you can pay all your debts on time your score on this section will be high. This way bank will be sure that you know how to manage your financial assets and pay off your debts on time.
- 20%: Percentage of credit used - It is the credit utilization ratio where your balances are divided by the available credit. In simpler terms, it is the available credit amount that you use. For instance, let's say you have $10,000 available in your account and you've used only $2,000. That means your credit utilization ratio is 20 %, which is considered favorable for the bank (favorable means less than 30%). You want to keep this score as low as possible to indicate that your total balance is at least 3 times less than the available credit. However, you shouldn't completely stop using your credit card. That may affect your score negatively.
- 11%: Total Balance/Debt - This section is similar to the credit utilization ratio where you want to keep it as low as possible. By lowering your debt amount, you increase your credit score.
- 5%: Your most recent credit behavior and inquiries - VantageScore also takes into account your most recent credit behavior while calculating your score. For instance, if you have recently opened multiple credit accounts, this would hurt your score. That is because the bank will be concerned about your ability to manage all of them successfully.
- 4%: Available credit - The lowest percentage allocated while calculating your credit score goes to available credit bank or credit union offers. If your credit score is high, the bank will offer you a higher limit for the next time, but it doesn't affect your score too much, as it has only 3% weight.
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FICO’s classification differs from Vantage’s as there are 5 categories, and the weights are allocated differently as well. Now that you know what the Vamyage score categories indicate, here are the factors FICO’s credit score takes into account:
- 35%: Payment history - For both of the scoring methods payment history is the most important variable while calculating your credit score. The difference in the FICO method is that it weighs less by 5% compared to VantageScore.
- 30%: Level of debt (amounts owed) - Your score is also based on the current amount you owe. The more your debt is, the less likely your new credit will be approved.
- 15%: Age of credit history - An essential factor for the creditor is to see whether you are new to the financial industry or not. This is meant to understand if you know how to manage your finances and pay your bills on time.
- 10%: Credit types - There are 3 types of credit- revolving, installment, and open. If you have all of those 3 types in your payment history, you are most likely to be approved for the loan. Banks and credit unions view you as a less risky customer because they know you are aware of the financial networks and how to manage 3 types of credits simultaneously. However, if you don’t intend to use those accounts and think that just opening those will improve your score, don’t rush to apply for any of them. According to the FICO scoring system, it is not professional from your side to open an account which you are not likely to use.
- 10% Credit Inquiries - The inquiries that are taken into consideration when calculating with FICO method are called hard inquiries. Those include information such as credit checks from your mortgage or credit card. FICO takes into account all this information within 45 days period. You can check your credit score at com, which provides up to date information every day.
According to the FICO rating, if you have a credit score of 630, you are in the range “fair,” where the scores vary from 580-669. 17% of the US citizens fall in this range and applications with such a rate are generally viewed as from subprime borrowers. VantageScore’s rating also classifies 630 as a Fair credit score with the range of 601-660. According to this method, you are likely to get credit but not at competitive rates.
This method also classifies borrowers in more categories than FICO.
While FICO has 5 categories:
- Very Good
VantageScore adds the 6th one which is very poor.
That is why, by FICO scoring, 84% of Americans are classified in the categories of fair and above, while by VantageScore only 74% fall in that range.
How to get a loan with a fair credit score?
Apply for Personal Loans
If you fall into the range of Fair borrowers, you should consider personal loans. Unlike other types of loans, personal ones don’t have a very strict and lengthy process.
These can have very flexible terms, which may be advantageous for both prime and subprime borrowers. You can use this type of loan for various purposes without limitations.
They are also “unsecured,” meaning there are no pledged assets under the contract terms.
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Get your loan from Credit Union
Unlike banks, credit unions don’t base their decision solely on credit scores when the client applies for credit.
However, the important thing is that you should get a membership to get credit. The other factors that are taken into consideration before giving you a membership are not only your financial health.
These also include information about where you live, work, and even to what school you went to. If you are interested in the details of how credit unions function, you can do your research here.
Apply for a Secured Loan. What is a
If you want to improve your chances of getting credit approval, you may apply for a secured loan. That means you will offer an asset- immovable or vehicles, to the bank or credit organization as collateral. A secured loan will increase your chances of getting an approval. And if you fail to repay the credit, they will cover their losses by selling your assets.
Have a Guarantor/ Co-Signer
Another option if you have a fair credit score is to get a guarantor. This way, the bank or credit union will pay attention to the guarantor’s credit score as well. So if your guarantor has a good credit score, your chances of approval get higher. You should also keep in mind that this person will share all the credit duties with you equally. Whenever you are unable to pay your debt, they become responsible for it, and any breaches will affect both of your credit histories and scores.
Avoid using Credit Cards
When you research the terms and conditions of credit cards, you will see the annual percentage rates are higher than on personal installment loans. You should be careful with your credit cards, as calculations of credit score both by FICO and VantageScore weight credit card debt more, than personal ones.
So, if you are having trouble with your repayments of credit cards, this would negatively affect your score. What you can do is applying for a personal loan and shifting your credit card account to personal. That would lead you to two positive outcomes both regarding improved credit score and advantageous loan terms and conditions with a lower annual percentage rate.
If rejected, write a reconsideration letter
If you have been rejected with your current credit score, you can write a reconsideration letter. In this letter, you ask for a reconsideration of your previously denied application and present trustworthy evidence to creditors to prove you are financially healthy.
You may add supporting documents regarding your updated financial conditions or simply explain why you are a trustworthy borrower. In many cases writing a reconsideration letter works and a bank or credit union may give you credit.
Your Next Step
Approval of one loan does not necessarily mean your credit score is automatically improved. You should continuously monitor your credit history.
If you have multiple loans, be careful with your repayments, and be sure not to overuse your credit line. For that, there are specific actions you should undertake to improve your credit score and get the loan easier once you apply for it the next time.
Monitor your Finances
Credit monitoring services are beneficial for you to track your finances, see how your credit score changes, and budget your future finances. Many of those websites are free and provide various useful tools such as budgeting, credit monitoring, calculating your credit score, and giving you financial advice.
Monitoring finances has been one of the most effective ways for many users to gain financial stability and manage their finances effectively.
Pay Bills on Time
For your next borrowing keep in mind that your credit history plays the most influential part while deciding whether or not institutions can provide you a loan. Build a positive credit history by starting to pay your bills on time. Your credit score can be drastically improved, and it would be easier to get a loan once you apply for it. Make sure you are aware of your repayment schedules and do not miss any deadlines with a bank or credit union. That can negatively affect your score.
Systematic reduction of credit balances
As you already know, your current credit accounts play a significant role when deciding whether you are qualified to take a credit or not. If you have more than one account, start with the one which has the least balance. You can pay off that one faster, raising your score and then continue doing the same thing with the rest of your accounts.
The other tip which can be helpful to build a positive credit history IS NOT closing your credit card whenever you have stopped using it. Let me explain how it works. We have already talked about the credit utilization ratio and how the low rate indicates a high possibility of loan approval. In this case, if you do not have any other expenses to cover your debt will equal to 0.
As now you have a long credit card history, it will improve your score more drastically than with the new credit card.
Charge what you can afford
If your credit request is approved, you should always keep in mind to purchase stuff which is necessary and which you can pay off in the future. Try to create a budget beforehand and stick to it not overusing your credit card. As already discussed, credit card history has the most weight, which in its turn is the major component of your credit score calculation both by FICO and VantageScore. So try to minimize your debt amount.
Pay more than the minimum due
If you have saved from the last month and your next scheduled payment is due soon, make sure you pay more than the initially scheduled amount. This way, you can lower your credit utilization ratio, raise your credit score, and be able to pay off your debt faster by saving more on interest.
After the financial crises, caused by consumers’ inability to pay off their debts, banks and other financial institutions have become more alert. They have developed scoring methods to foresee their probability of defaults. This way, their businesses and the economy as a whole won’t be hurt and will help the country to function effectively. Even if you have a relatively low credit score, it is never too late to start working on improving it.
Do you want to boost your credits core and become a favorable borrower for banks and other financial institutions? If yes, then start taking steps toward changing your financial behavior today.
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