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What is credit scoring and what impact does it have?

Overview  

Every bank wants to be sure that its customers are able to repay their loan in time – otherwise they might lose a lot of money. This is why they usually access their customers’ credit files before closing a loan contract or selling any kind of financial product. But where does all this data come from? The answer cannot be generalised for all the countries in the world but normally there is at least one agency that collects personal and credit-related consumer data. It then provides companies with the necessary information about a person’s solvency.

Based on this information, a credit score is usually calculated in order to be able to categorise the customer’s solvency. This makes it easy for a bank to decide if a person is creditworthy or not. The calculation process is usually very complex and not known to the public – it may vary from agency to agency, too. Generally, it can be said, though, that consumers who dutifully pay all their bills in time achieve a better score than people who have a negative credit history.

Data collection

It is not only credit files that these agencies collect, though. Mostly, personal data, such as addresses, is stored, as well. In some countries this data is used to make assumptions about a person’s creditworthiness, as well. If you live in an area with a high number of people who have a low solvency, it is less likely for you to be granted a loan.

Further, information about financial products and services that have been used in the past can be found in their databases. Banks and other companies access this data in exchange for a contribution to the data pool. This way, the information always stays up to date and the credit agencies can create a very exact statement about a person’s solvency.

Banks and other organisations accessing consumer data are not the only contributors to the data pool, though. Often, publicly available informations like debtor registers or court information is combined with the data provided by organisations cooperating with credit agencies.

How it affects your credit eligibility

As mentioned above, your credit score is very often the decisive factor for a bank to decide if it grants you a loan or not. However, some banks do not reject you completely for having a negative credit history but only adjust their interest rates in accordance to your credit score. This means that you might still be able to receive a loan, however, your interest rates will be higher than for people with a better credit score. This way, the banks want to hedge against potential losses through a customer’s insolvency.

Each bank has its own guideline on accepting customers with a low solvency. So if one bank rejects you, it does not mean that all the other banks will do so, as well. However, you should be aware that even an application for a loan can have an impact on your credit score. Therefore it might make sense to gather information about the banks’ conditions for accepting customers with a low credit score, before applying for a loan.

There are some banks out there that grant loans without a prior solvency check. However, you should thoroughly engage with their offer before deciding to accept the loan. Mostly, these banks offer very high interest rates to hedge against their potential losses. This might easily cause you to slide into further debt. If you are thinking about a loan without credit check to repay another loan, you should rather consider getting help from a debt advice center, for example.