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How Your Credit Score Is Determined

There are a lot of myths that surround the concept of a credit score and credit history, so it’s a good idea to sign up to one of the services that can show you this information first hand.

Your credit report is simply a history of the payments you have made to credit accounts (be that loans, mortgages, credit cards, or phone bills), showing completed and missed payments. No judgement is made about these payments overtly, though lenders may make judgements from them. You will also find a credit score. This can be compared to your GPA at school, a running measure of your overall success compared to other students (or in this case borrowers). The better your score, the more credit-worthy you are generally seen by lenders.

What Is Your Credit Score?

The score is now also commonly used as a measure of your overall reliability. Everyone from your boss and landlord to insurance firms and business partners, may want to seek this out to help them make a judgement about how responsible you are. Gone are the days of it simply being used to determine whether you should be issued a loan and what interest rate will apply.

To keep things easy, lenders will have an internal bracket system and assign your loan an interest rate based on which bracket your score falls between. Similar brackets can be seen on your credit report itself, with terms such as poor, average, great etc. The most common score adopted by lenders and report agencies is the FICO scale, which measures your credit score between 300 and 850. An excellent score, where you can access most forms of credit and at good rates is generally over 740. You can still get credit below 650 but will progressively get fewer choices and higher rates. Anything close to 300 and no reputable lender will want to do business with you.

Internal scoring can also be very rigid from lender to lender. Just 15 points either way can completely change that amount of interest you’ll pay on a loan. This is especially true for mortgages where somebody with a 680 score could get as low as 4.7% over 30 years, whereas somebody with 665 would likely be charged over 5%. Over the lifetime of the mortgage that can be quite the sum of money.

How Is It Calculated?

While everyone knows that your credit score is calculated based on the credit history detailed in your reports from rating agencies, the exact factors and algorithms are not publicly known. FICO for example do not give away their specific formula, but they have revealed over the years that they strongly factor in your history of repayments, the amount you currently owe in outstanding debt, how long you have been active as a borrower (when you first got your credit card etc), whether you recently obtained credit, and the types of credit you use and have used.

The single most important element that goes in to your score and what most lenders are really trying to ascertain, is your payment history. Whether you have struggled paying or completely missed making payments in the past. This is a strong a sign as any that you are a reliable borrower or not. Even if you borrow a lot, so long as you meet the obligation your score should be ok.

Outstanding debt however is still an important part of the puzzle. If you have too much debt and your accounts are close to maxing out, new lenders will be concerned that you will be unable to take on any new debt.

Your utilization ratio is how much debt is outstanding compared to how much access to credit you currently have. For example you could have three credit cards at $3,000 each, but only have a balance of £100 on each. While there’s always a risk that you suddenly max them out, you are in a better position than having £2,000 on each card.

The longer you have been an active borrower, the more history you will have and the more data rating agencies and lenders can work with. This is good. If you have just taken out new credit your score may dip temporarily as your score and reliability is reassessed. It can therefore be difficult to take out lots of new credit at the same time.

The smallest factor, but still one worth considering, is the variety of credit accounts you own. If you can prove yourself responsible with loans, credit cards, mortgages, business accounts etc, you will get a better score than somebody in the same position who uses credit cards only.

Top Myth

A common myth among young people is that the less debt you are in the better your credit score, and you should avoid credit cards and loans if you can. This is not true. In order to build up a solid credit score you need to actively show your ability to borrow and repay throughout your life.

Choosing Between Loans and Credit Cards

All of us at some point in the modern world need credit, but it’s far from easy to decide the form in which to obtain it. Perhaps the two most common choices are credit cards and loans, but even then it can be a bit daunting. We take a closer look to help you make the decision, and it’s not always down to the best interest rate.

Unsecured Personal Loan

Since we don’t all have millions in our coffers, a generous rich great aunt, and taking out equity from our home just seems counterintuitive after plugging away at a mortgage for so long – a personal loan is always worth considering when looking toward that particularly large but manageable purchase. However because you do not have to pledge any collateral, interest rates on personal loans are some of the highest in the industry. This is not necessarily comparatively bad, after all a mortgage might have a better rate but it’s still going on hundreds of thousands of brick and mortar. Your personal loan may be for just a few hundred dollars. But it’s still worth keeping in mind when comparing to other products.

Personal loans are for a set principal amount, over a set period of time (months to years), and typically with a fixed interest rate. You’ll know exactly how much you will be paying each month. For the boxed minded, there’s certainly nothing to get confused about. If you know what you want to buy and have worked out your sums, it may be the perfect option for you.

The majority of lenders aim to lend more than $1,000 to make it worth their while. If you have a good credit score and a stable income, you can even go as high as $100,000. After this you’ll need to offer collateral.

The one catch to some personal loan lenders is that they require an origination fee that can be as high as 5% of the principal.

Credit Cards

Credit cards can carry even higher rates than personal loans, but the way they function can also be much more convenient and save you money in the long run. Firstly the interest on a credit card balance is not fixed over a set period of time like a loan. You don’t spend £3,000 on a card and then get stuck with a 12% rate fixed over 12 monthly instalments. Knock off £500 the next day and interest only continues to be applied to £2,500.

Secondly and perhaps the key benefit of the trusty plastic is that you don’t actually pay any interest at all for the first 30 days after using it, whereas with a loan you are paying interest from day one. Of course you have to pay the credit card company back pronto, but until that point it’s as good and cheap as cold hard cash. That makes credit cards ideal at least for smaller day to day purchases that you can cover within your monthly budget. It’s only after those 30 days (perhaps when you splashed out on that holiday) that the interest hits (and hard depending on the rate).

Another benefit of credit cards that might give them the edge in your mind is their versatility. You don’t have to carry psychical money around with you; all transactions are protected by the card issuer and can be easily disputed and reversed, and then there’s online shopping. Who doesn’t love online shopping? The trade off is the interest, but as mentioned above – you don’t have to give them that if you’re smart.

Conclusion

The debate then really becomes one of personal circumstance. If you can realistically afford to put everything you want on a card for 30 days and then pay it off to avoid interest altogether, then you should choose a credit card over a personal loan.

If you’re in luck you might also find some introductory rates and interest free purchase periods that really do rival loans for larger purchases over the long term as well.

Personal loans however are always better for larger purchases, especially if it will take you more than a year to pay everything back and you don’t trust yourself with a credit card, which is ever so tempting to overindulge with.

A rule of thumb is that if you want to spend over $5,000 (which is higher than the average person’s credit limit on their card) or you want to spend over $1,000 and this will take you more than 15 months to do so comfortably, a personal loan is the much better choice. Of course your own financial situation may dictate otherwise.

The Top Benefits of Payday Loans

Payday loans are just one of many forms of credit that you can access to help ease your financial situation. They are often issued by smaller lenders and online rather than by banks or large storefront lenders, but they are growing in popularity across the world. In the United States payday loans are regulated at the state level and they are also well regulated in Europe. Depending on your personal situation there may be many benefits to taking out a such a loan, and here are just some of them:

They Tide You Over Until Payday

The original purpose of a payday loan was to give the borrower a small sum of money to tide them over until their next pay check arrived – hence the term “payday” loan. Most loan terms today can still be worked out in this manner or usually for around two weeks. This makes them the ideal choice if you have accidentally gone over your month’s budget or face an unexpected bill, which can be easily covered once you get your next round of wages. Think of it as a cash advance from your boss, but from a lender instead.

Manageable Amounts

Payday lenders deal in relatively small amounts of money ranging from a few hundred dollars to £1,000 or more in rarer cases. Because the amounts are typically on the smaller end, it’s not likely that you will end up struggling to pay the money back unless you were not honest in the application to begin with. Once you’ve paid off one payday loan it’s very easy to apply for another, and there is no limit on how many times you can do this. In the long run it’s a safer option borrowing small amounts every so often, than taking out one large loan in one go that you could end up struggling with.

Short Term Commitment

A standard payday loan is typically due just two weeks from the date it was issued, making it a very short term commitment compared to other loans. This means you do not have to worry about months down the line when you’re still paying off the loan and may be faced with other financial problems, which can be the case with a longer term commitment. In many cases the loan will be deposited and repayment taken automatically from your bank account. It’s the perfect stress free option if you just need to buffer some bills until your pay check arrives.

Easy To Understand Fees

Because payday loans are a short term commitment that you repay in one lump sum, with no installments, it’s very easy to understand how much it will cost you. Put away that calculator! If you make this repayment on time there is only one single finance charge and this is clearly presented to you before signing any contracts. Although it may be based on an Annual Percentage Rate, all you have to think about is that one fee. What’s easier than that? The only time extra fees and interest is added is if you fail to make the repayment on the agreement upon date, but this is still clearly outlined in the agreement.

Can Apply With Bad Credit

Payday lenders believe that even those who have made poor financial choices or struggled in the past, still deserve a lifeline if they need help with this month’s budget. That’s why they commonly accept applications from those with bad credit. Because the amounts are low and the commitment is short, it’s not viewed as the same level of risk as a larger and longer term loan. So if you don’t have the best credit history and cannot get a credit card or traditional loan, a payday loan might be just for you.

No Faxing or Waiting In Lines

Payday lenders are often a step ahead of traditional lenders when it comes to technology. Most loans of this type are issued in minutes online, without the need to fax documents or wait in arduous lines at the bank. As long as you have an internet connected device you can apply for a payday loan right now and have the cash in your account by the next morning if accepted.

Improve Credit Score

Taking out a payday loan is a great way to rebuild or improve your credit score fast. Think about it, because the loan is only outstanding for around two weeks, your report will be updated in the blink of an eye. If you take out payday loans on a semi-regular basis, eventually you will have lots of examples of you successfully meeting your financial obligations and your score will rise accordingly. Other lenders will see you as a reliable borrower and the range of credit you have access to will broaden.