A credit rating works by gauging the credit worthiness of a person, or more generally, an evaluation of the likelihood of a borrower to default on a loan. A Credit Rating Agency assigns the credit rating.
It follows that people who pay their dues promptly are considered good credit risks. Conversely, a poor credit rating indicates a high risk of non-payment on a loan.
High credit risk can negatively impact the credit rating and affects one's ability to borrow money through financial institutions such as banks and credit cards, and if loan is granted the interest rate and other impositions applied to loans are high.
Your financial history and current assets and liabilities are the basis for calculating your credit ratings. This way a lender can assess ability of the borrower to pay back a loan.
As you would have known, interest rates are based on risk based pricing - a financial services procedure that charges different interest rates on the same loan to different borrowers, depending on their credit score and other factors.
Credit Rating Agency
Financial investors have recognized the value of credit rating agencies in increasing the range of investment alternatives. Their operation may also lower the costs for both borrowers and lenders. In Australia and New Zealand, Baycorp Advantage (ASX: BCA) is the largest credit bureau, which handles credit scoring, credit reporting, debt collection, and marketing investigative services.
To facilitate faster and easy evaluation, and speed up the issuance of loan or credit extension, Creditors or lenders, such as banks and businesses, are provided by credit Bureaus and Credit Reporting Agencies with credit information and related personal financial data.
As necessary, important credit information and supporting papers may include:
- Personal information
- Employment information
- Payment history
- History of past credit problems
- List of current and past credit accounts including balances
A credit rating is handed out differently in different countries, but the general concepts apply such as payment record of paid bills; control of debt; signs of stability and responsibility including professional and income standing. Most creditors also recognize 're-aging' where a credit history is re-written and a fresh start can be granted on that particular account.