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Credit Score. In your credit report you are assigned a credit score . It is based on a formula created by a company named Fair Isaac Corporation (FICO ® ) . Most lenders use the FICO ® score to assess risk. Credit scores range from 300-850. A credit score between 750 and 850 means you are a low risk borrower who will likely be able to repay the loan. Generally, a good credit score is between 680 and 749 and an acceptable score is between 620 and 679. Below 620 indicates a risky borrower. A low credit score effects your ability to obtain credit. Maintaining a good credit score is important because it gives you access to better borrowing options such as lower interest rates. If lenders know they can trust you to pay back the debt in a timely fashion, they’ll be willing to let you borrow more money and on better terms.
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Free look! Go ahead - check it out. You can get one free credit report every 12 months from each of the three bureaus. Checking your own credit score does not affect your credit score.
Debt-to-Income Ratio. Another thing a creditor will use to assess your credit health is your debt-to- income ratio (DTI) . This is the amount of debt a person has as compared to their overall income . For example, if you make $4800 per month in income and pay out $2200 a month on your debts, your debt-to-income ratio is 45%. DTI is calculated by dividing monthly debts by monthly income. In this case, 2200/4800 = 45%. While a DTI ratio doesn’t show up on a credit report or impact a credit score, a high DTI ratio will convince some lenders that a borrower is a credit risk. For that reason it’s important to avoid taking on high levels of debt , particularly credit card debt. Reflect on Learning: Can you list the information contained in a credit report, tell about the FICO credit score range, and explain what a debt-to-income ratio is? VII. Building Good Credit The Credit History Conundrum. Getting a bank or other lender to loan you money requires that you have a credit history. This presents yet another vexing problem: How can you get credit if you have no credit history, and how can you build a credit history without credit? Three popular ways young people build a credit history are student loans, auto loans, and secured credit cards . If you have a regular income and not a lot of debt, it’s not hard to get a car loan. Most car dealers offer in-house financing and the credit requirements are less stringent than a bank’s. A secured credit card functions much like a regular credit card. The difference is that your repayment obligation is secured by a deposit you make with the lender which is usually in the amount of the credit limit on the card, such as $1000. If you don’t make your monthly payment, the creditor can draw on the deposit. Making regular monthly payments on a secured credit card creates a record of consistent repayment of your debts, which builds a credit history. Student Loans Post-College. In your senior year of high school, you’ll receive plenty of information about different kinds of student loans, how much you can borrow and from whom. However, many students don’t understand what happens with their student loans after they graduate college. Like any other form of credit, student loans have to be repaid with interest. Student loan creditors report to credit bureaus just like any PRODUCT PREVIEW
Chapter 7 | The Credit Conundrum 122
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