An individual's credit score is a three-digit number that attempts to compile all of the information about how that person has managed credit. Credit bureaus gather data about the person's credit accounts, money-related court records, credit applications and payment history. Gathering the data and converting it into a credit score can be advantageous or disadvantageous to the borrower in several areas.
Expedite Credit Decisions
Credit scores are advantageous for lenders who need to make credit decisions quickly. A lender likes to know as much as possible about how good of a borrower the applicant will be. A credit score encapsulates a lot of data in just one number so the lender can, at a glance, determine approximately how much of a risk the borrower is. It would take much longer for the lender to research the borrower's history directly with other lenders. This expedited process decreases the cost of borrowing and makes credit more widely available.
Determine Interest Rate
Lenders use potential borrowers' credit scores to determine what interest rates to charge. This can be either an advantage or a disadvantage, depending on whether the borrower's score is above or below average. People with good credit scores are rewarded for their good borrowing habits with a lower interest rate. On the other hand, people who have bad credit scores will pay for it as they have to pay a higher interest rate on all of the money they borrow.
Compile Long-Term Data
A credit score compiles information about all of the borrower's open accounts, plus positive information about accounts that have been closed for less than 10 years and all negative information from the past seven years. This can help or hurt an individual. It is advantageous for someone who has managed credit well over the long term because one mistake usually does not have a disastrous effect because so much positive information outweighs it. On the other hand, someone who has managed credit poorly and is trying to turn his financial condition around will have to spend a few years managing credit well before the score accurately reflects his new habits rather than the old ones.
Doesn't Reflect Unusual Situations
Many factors can affect a borrower's credit score, and in some cases, the credit score does not reflect a borrower's responsibility with credit. For example, if a couple is on the verge of a nasty divorce, one spouse might purposefully run up a joint credit card balance or fail to pay bills just to ruin the other person's credit. Or someone might have had to pay for expensive unexpected medical treatments that made it impossible to keep up with bills, even though the borrower would have been fine if the medical treatments had not been needed. Individuals can add a short explanation to their credit files, but lenders do not always consider such explanations.
Require Additonal Monitoring
Credit reports are not always accurate. Individuals often end up with accounts on their reports that do not belong to them or inaccurate reports of late payments. Although credit bureaus allow individuals to dispute information, the process is not instant and in some cases, the dispute does not turn out in the individual's favor. Keeping a credit report free of errors is just one more thing for individuals to worry about.
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