Lenders use your credit score to determine creditworthiness, so knowing your score is essential, whether you're planning a major purchase or applying for your first credit card. A credit rating serves as a business tool, compiled by a recognized credit-rating agency. Lending institutions use the ratings to determine the level of risk associated with an individual debt issue for a corporation or government entity.
Using software developed by FICO, the big three credit-reporting agencies, Equifax, Experian and TransUnion, establish your credit score based on your credit history. Each agency tweaks the software to suit its credit parameters. As a result, each agency can report a different credit score.
As of May 2010, Standard & Poor’s, a respected credit-rating agency, considers an issuer’s credit quality under conditions of moderate stress when determining a credit rating. This methodology -- used by financial institutions and investors to measure ongoing risk -- addresses the possibility of ratings changes over a three-year period.
FICO scores range from 300 to 850, with your final score including five elements. Payment history makes up 35 percent of the total score. Thirty percent of the score is based on the amount you owe. Length of credit history checks in at 15 percent, with new credit and types of credit used comprising 10 percent each. Commercial credit ratings use letter grades, ranging from AAA, which signifies an extremely strong capacity to meet financial commitments, to D, which reflects payment default on financial commitments.
Because credit scores have a direct relationship to the interest banks charge, maintaining your credit score proves crucial in the credit process. The higher the credit score, the lower the interest rate or cost of credit. Like personal loans, ratings for corporate or government borrowers that fall in the lower-letter-grade categories, BB to D, make it more difficult to obtain bank financing, and if obtained, account for a higher rate of interest.
Check your credit report and your credit score often, and address incorrect information immediately. You are entitled to one free credit report each year, although the credit agencies will assess a minimal charge for your credit score. As your report and your score can vary significantly from one credit-reporting agency to the next, get both from all three major companies. You can also obtain a free credit report, if requested within 60 days, if you're denied credit for any reason. If your job includes policing your company or city’s credit rating, establish a strategy to keep the letter grade above BBB-, which ranks as the lowest investment grade by major market participants.
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