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Credit Scoring and Its Impact - Essay Example

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A credit score refers to a statistically based means of evaluating the expected repayment performance of a loan that can substantially decrease the time cost of reviewing applications, and human input.1 It is a three-digit number based on a borrower's bill-paying history and debt profile…
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Credit Scoring and Its Impact
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Download file to see previous pages It has an important influence on the interest rate incorporated to the borrowed money. With the significance of credit score, knowing it enables an individual to question the accuracy of the score, and as a result, negotiates the best rates with lenders. A credit score is purchased separately and is not a part of a consumer credit report. One may purchase a credit score from a consumer credit reporting agency, who can charge him/her with a reasonable fee.4
Credit scores are used other than determining whether a person will default on a loan or make late payments. Low credit scores are used by usurers in order to identify individuals whom they believe are likely to make claims on their insurance policies. An accurate credit score can enable interest rates be charged on loans and can make a difference on the availability and cost of insurance.5
Mathematics models are used in calculating credit score, which analyzes the creditworthiness of a person. The amount and types of debt that a person owes are considered by the models. The person's repayment history will then be analyzed alongside thousands of other consumers in the credit store. Important factors that determine a consumer's credit score are his/her previous payment behavior, the amount of money he/she owes, the length of time that he/she has held outstanding credit, the type of credit he/she uses, how much credit is available to him/her, and whether there are inquiries from prospective lenders in his/her file.6 The amount of available credit that a consumer is using is one of the most important factors in his credit score. When credit card companies do not report the credit limits on a consumer's account, the consumer's credit scores can be lower tan they should be. This is because most credit scoring systems substitute the highest balance for the missing credit limit. Since it will appear that he is using all of his available credit, the borrower's credit score will become lower. Thus, it is important that consumers deal only with credit card companies that report credit limits on their accounts.7
Credit scores have varying meaning. The higher the score, the better the credit rating. Generally, a credit score can vary from 300-850, in which most scores fall within the range of 600 and 700. A sub-prime loan, which is a boundary between a standard loan and a higher cost loan, is generally tantamount to a credit score of 620. An easier time to obtain credit and a likewise ability to obtain it on better terms and at a lower cost is the implication of a higher credit score.8
The credit bureau and a model developer need to validate a model that will be utilized for credit scoring. Developers often perform additional validations on independent samples before releasing a model, in order to be assured of the model's predictive capability.9 Pincetich, et al10 suggests that in order that a credit bureau score may be used effectively, it is important that accounts are analyzed to determine how the score relates to a specific situation, such as delinquency or bankruptcy. Although the scoring logarithm remains the same, the performance related to each score may possibly vary according to user. Hence, a ...Download file to see next pagesRead More
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