The Role of Credit Scores

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A credit score is a numerical value based on a statistical analysis that represents the creditworthiness of a person. Credit rating companies test the creditworthiness of customers or partners, according to a predetermined automated procedure, which employs algorithms.

Credit scores are requested by banks and other financial institutions offered by a number of specialized companies (credit agencies). Without such a score, it is very difficult to get a loan or credit card.

A very low credit rating can lead to the rejection of an application, while a slightly lower score might translate to a higher interest rate applicable on the credit – and/or additional collateral is required.

Most major credit rating is determined by the Fair Isaac Corporation, also known as FICO, the institution issues the scores which are specified as the FICO score. They take form of a number between 300 and 850, which allows for precise calculation.

The motivation for the method is to avoid risks, on the basis of a statistical method that allows padded decisions. The better FICO illustrates the underlying scoring model, the less credit losses there will be. Scoring models with inflowing characteristics must be constantly maintained.

The specific rules and algorithms of the scoring and weighting are also based on a score card (named after the homonymous term used in sport). There are several techniques to develop appropriate scorecards, and these include logistic regression, discriminant analysis, artificial neural networks and other techniques.

The following components are important elements in calculating the credit score: timeliness of payments in the past (with which only payments over 30 days late, are taken into account). In addition to the size of the current debt on credit cards and other loans related to the maximum allowable debt. The history of various appropriations, and the type of credits that the applicant used as well as recent withdrawals of the credit status of the applicant.

A borrower’s credit score can be improved by a proper payment behavior, and the limit(s) on the credit card(s) not being fully exhausted. Poor payment behavior of the past disappears over time from the score, but this is only after several years.

The credit scoring model has advantages over conventional methods. And these include standardization, empirical validation (objectively comprehensible), IT technical refinement is possible. Automation of the credit decision process makes it more economical for the lender (which need not necessarily be banks, since the procedure also works with commodity finance),and enhances acceleration of the credit decision as well as time and cost savings.

 

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