Credit Scores are a Fair Measure to Help Lenders Estimate Potential Risks - Essay Example

To simplify their customers’ analytical process, mathematical algorithm can be used by different bureaus to provide a score that customers can use to rapidly assess an individual’s likelihood to repay a certain debt, if the frequency by which other individuals in such situations default in meeting their obligations is given. This means that credit bureaus have to create several credit scores for many individuals. Credit scores that are over 700 are pretty good, and most of them go up to 800 (consumer Reports, 2005).

The most widely used method of calculating credit score is FICO, though there are many other methods. It is normally used by mortgage lenders, who use risk-based system to find out the possibility of a borrower to default financial obligations to mortgage lenders. It is important that each individual is always aware of his credit score so that you can work towards improving it. Individuals are therefore advised by consumer welfare advocates to review their reports of credit at least once every year, so as to ensure their accuracy, and hence increase chances of their credit qualifications (consumer Reports, 2005). . It offers the best measure of credit risk without individual discrimination in terms of age, sex, gender race or occupation.

Credit score is calculated using different data that is found in your credit report. The data is then grouped into five different categories, each with a percentage reflecting the importance in the determination of your score. They are categorized as payment history, amounts owed, credit history length, new credit and other types of credit used as 35%, 30%, 15% 10%, and 10% respectively. All these scores play a vital role in the formula, which then determines your credit score. Credit scores help lenders to estimate the potential risk of giving credit to individuals.

Credit reports and scores can affect an individual during tough economic times. Furthermore, it plays an important part in determining an individual’s financial well-being. Credit scores are used by lenders to determine who to give a loan, at what rate of interest, and the credit limit. According to consumer Reports, (2005), the three major bureaus of credit: Equifax, Trans-union, and Experian, that calculate FICO scores based on data collected from credit card companies and banks. How Credit Scores and Reports are Used Lenders like credit card companies and banks use scores of credit in evaluating potential risks that may be posed by lending money, as well as mitigating losses that result from bad debts.

They determine loan qualification, interest rate, and credit limits that lenders may accrue the consumers. It is a trusted system of authorizing the accessibility of credit among individuals. Since it is not limited to banks only, other organizations like insurance companies, government