Contributed by cPort Credit Union
Sometimes people don’t have enough money saved for what they need. Perhaps a car breaks down and needs to be repaired quickly. Or a new job requires the purchase of a vehicle. Or maybe students want to enroll in college courses. In cases such as these, people might consider applying for a loan from a financial institution.
Lenders (the financial institution) may loan money to borrowers who promise to pay the loan back. In compensation for the convenience to the borrower of getting cash up front, the lender generally adds an interest fee to the amount the borrower then owes. Over time, the borrower pays back the amount borrowed, and also pays back the interest. A loan helps the borrower because they can access the funds they need. And loans benefit the lender, because they earn interest on the money they lend, creating income for the company.
But how does a lender figure out if lending money to a particular individual is a good idea? First of all, they check how much risk is involved in making a loan to an applicant. They consider if the person is working (and how long they have worked), and look at their credit history. Credit helps forecast how reliable a person will be at making payments. This is one reason establishing and working to improve one’s credit score is important – good credit helps a financial institution have confidence in a borrower, and will help ensure a borrower will qualify for a loan when needed.
When reviewing a credit or loan application, lenders look for a stable income source, work history, and a place of residence. They also run a credit check. Lenders pull a report from a credit bureau such as Equifax, Experian, or TransUnion. These companies provide detailed histories to help a lender determine if a candidate qualifies for a loan. For example, a lender can see how many other loans the borrower might be outstanding, or if the person has missed payments in the past.
If someone is new to the country, and doesn’t have a credit history in the U.S., they can talk to their credit union or bank for help in establishing credit. This could involve taking out a small, secured loan to start a track record of loan payments. Some credit bureaus add payment information from utilities (like gas, water, and electric bills) to help establish payment patterns.
A credit score is a snapshot of how well a person manages and pays back money. A person with a high credit score can more easily qualify for a loan than someone with a middle or low credit score. It’s essential to monitor credit and improve it in any way possible. This could make the difference between receiving or being declined for an auto or personal loan or even a mortgage. One’s credit score also helps determine what interest rate will be attached to loans and credit accounts. Generally, the better the credit score, the lower the interest rate.
The information in credit scores includes the following:
- Personal information: name, address, Social Security number, date of birth, and employment information
- Credit accounts: loans or credit cards, including spending limits or loan amounts, and payment histories
- Credit inquiries: the number of times other lenders have processed a credit check on the potential borrower’s credit report
- Public records and collections: public information from state and county courts, including bankruptcies, and debt that is overdue and has been sent to collections, which also appears on a credit report
These are some ways credit is used:
- To determine interest rates: The better a person’s credit score, the lower the interest rate. Even a tiny percentage difference can save hundreds of dollars over the lifetime of a loan.
- To qualify for a loan or credit account: If a person misses payments or has a high amount of debt, lenders might hesitate to finance a loan or credit account.
- To rent a home or apartment: Some landlords require a credit check to rent a house or apartment. Payment history can be critical in this situation.
- Securing insurance coverage: The best home and auto loans can be secured when credit is managed well. Credit issues will make people look risky to insurance groups.
- Acquiring a job: Many employers require credit checks as part of their evaluation. Maintaining a good credit score can help employers determine how well an applicant understands managing money.