What is a credit rating and why does it matter?

Credit ratings are based on information provided to certain agencies by lenders, usually banks and credit unions, regarding their experience with a borrower in the past. These ratings are then used by other lenders, should this borrower submit a loan application, to determine whether advancing the loan is a sound business decision.

Credit ratings are accessed so frequently by lenders because past behaviour has proved to be the most accurate means of predicting how the borrower will manage credit in the future. If a person has a low credit score, he or she is likely to be refused the loan. If the loan is advanced, it’s more likely to carry higher interest rates and lower credit limits, to offset the increased risk to the lender.

Credit ratings are also used by prospective employers as a general gauge of responsibility. This is particularly true for positions involving a high degree of financial trust. Credit ratings can also affect the terms of rental agreements and insurance policies, and so it’s quite important to build and maintain a good rating.

Although repaying previous debt is usually the most important part of the credit rating, there are several other factors involved. Having a regular job or a brief series of regular jobs, and staying a long time at a residence, can contribute positively to a credit rating, as such factors demonstrate a settled pattern of behaviour, which also tends to influence the borrower’s ability to repay the loan.

Another factor is the person’s total amount of debt, as well as when and how it was obtained. If a lot of credit has been accessed in the recent past, this is often a warning signal, either that the applicant expects financial trouble, or that the applicant’s finances have spiraled out of control.

There are some ways to improve a credit rating, several of them involving credit cards. The most straightforward is for the applicant  to take out a card with a manageable credit limit, to charge a small amount each month, and to repay this amount in full every month. In this manner, the person is able to demonstrate a responsible attitude toward money, which is what the credit rating is designed to measure.