What criteria do lenders use to evaluate risk?
1. Payment History – The repayment history of your previous debt. The more derogatory information in your previous payment history (late payments, collections, charge-offs) the higher the credit risk. If you have a perfect payment history with no derogatory information – you will be considered less of a credit risk, have a higher credit score, and have loans available to you at much better terms.
2. Credit Utilization – The proportion of the amount of credit you have available to you in relation to the amount of credit available to you. Basically, if you have a lot of available credit lenders will consider you a lower risk for default as opposed to someone with very little available credit (i.e. maxed out credit cards) who is considered riskier.
3. Length of Credit History – How long you have had established credit. Someone with a long length of credit history, accounts which have been open and active for 10–20 years, will provide lenders with more data from which to make a lending decision. Someone with a short payment history, accounts of less than 2 years of activity, will not be able to provide much data to lenders on the consumer’s ability to repay a debt.
4. Mix of Credit – The ability to responsibly use both revolving and installment accounts. Lenders want to know that you can responsibly manage and repay both installment (accounts with a set length of term like auto loans, mortgages, student loans) and revolving accounts (credit cards and lines of credit). Having both revolving and installment accounts reporting in your credit reports with no late payments will make you look less risky than someone who only has either installment or revolving accounts.
5. New Credit/Inquiries – Recently opened credit accounts and credit applications. A consumer with many recent credit applications or many new accounts recently opened is a higher credit risk than someone with very few recent applications/new accounts. This is because lenders fear that a consumer who is establishing too much credit at once may be in a bad financial situation and is acquiring new credit off which to live off. Establishing your credit slowly is a much better idea. You don’t want to look desperate for credit.
In Summary, in order to get the best credit score possible and look like a safe as possible to lenders who are evaluating your credit risk, you will want to pay your bills on time, keep a low credit utilization, establish a long length of credit history, maintain a good mix of credit, and build your credit slowly.
And if you have derogatory information in your previous payment history hurting your credit scores you may want to work on removing it from your credit reports or hiring a professional credit repair service like CreditFirm.net to do so on your behalf.
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