Why Do I Need Good Credit? Or may be another title is Can I borrow money if I do not have good credit?
What types of borrowers are most likely to need good credit in order to get financing in the first place? Lenders use a formula they call "discretionary income" to determine whether or not they will lend to you. Discretionary income is pretty much made up of two things: Your gross monthly income and how long you've had credit. As far as gross monthly income is concerned, the lender cares about how much you make over and above the amount you need to survive. So, if you have a very high-paying job and a large excess over and above your basic necessities, the lender will probably not care that you have poor credit. However, if you are struggling just to get by, even a tiny deficiency in your monthly income will cause the lender to automatically categorize you as having poor credit. In truth, most people with marginal or no credit have more discretionary income than people with good credit.
How do lenders make their decisions? It is important to remember there are three types of credit bureaus: The main ones are: Experian (300 million records) TransUnion (900 million records) Equifax (700 million records) Each of these bureaus has a different level of detail in the information they report about you. Lenders use all three of them to make a decision about whether or not they will lend to you. Typically, they look at the combined information from all three. The main thing they are concerned with is whether or not you have a history of paying your bills on time. If you have a long history of on-time payments, this tends to indicate you will continue to pay your bills on-time even if you have one or more poor credit reports.
Lenders also look at your total debt-to-income ratio. If you have a very high ratio, this tends to indicate you will be extremely sensitive to any change in your financial circumstances and will find it hard to cope with an economic slump. On the other hand, if your ratio is low, this tends to indicate you will be fairly insensitive to slumps in the economy and will continue to spend sprees even if you have a bunch of negative entries on your credit reports.
Lenders like to see all your debts are current. If you have any delinquent debts or even just a few, this is a concern area to the lender and they will wonder why you have so much debt.
Do you make your payments on time? An obvious way to hurt your lending options is by missing a payment or two. Lenders will then will consider this a "red flag" and they will wonder what else you are doing that is not in line with a borrower that will pay back the loan. This will make it hard for you to obtain a good "standing" from the outset and make it even harder for you to obtain a favorable change in your standing when times are tough.
And finally, lenders look at your age. If you are young, this tends to indicate you will have a long life ahead of you and can easily repay the loan (assuming you are doing so on-time). If you are old, this tends to indicate you will be nearing retirement and will probably not have much income after taxes and other deductions are made.
What does all this mean in practical terms? If you are older and have a high income, it is more likely the lender will decide not to lend to you. Or let's say you have been out of school for two years and you have had "thin" or "no" credit history. You decide to go to a mortgage broker and apply for a conventional 30-year fixed rate mortgage. Without a doubt, you will be turned down.
That pretty much covers the basics of what lenders look for when determining if you meet their criteria for their decision to lend you money.
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