We are often advised to establish a good credit because it will help us in our future borrowings. But what is it really and what do banks and credit card companies look into when they check our financial background and history?
The credit score is a way to gauge the capacity of a borrower to pay back. It is a way for a lender to size up a client to determine if he will grant the amount of loan requested or not. It is like a credit report used to grade a client using three crucial factors. These are character, capacity and capital, or in short, the 3 Cs. By assessing a person in these areas, a lender could predict if his client could handle his financial obligations. Therefore if you are looking to establish a good credit history, learn how you will pass the 3 Cs with flying colors.
A borrower with good character is someone who always pays his dues on time. You may experience financial difficulties at one point in your life but paying your mortgage, credit card bills or other loans is still a financial obligation you have to settle. It speaks a lot about your character if you still manage to fulfill your financial responsibilities amidst the difficulties you are facing.
The second C is capacity. This is your actual financial ability as measured by your annual income statement and investment portfolio. Hence, a lender will try to read how much you are earning in a given year and how much you have invested in the past. It shows your capacity to pay back. Many lending companies set minimum requirements when you apply for a loan. You should be able to meet the minimum total annual earnings they set. The higher you earn in a year, the more qualified you are.
Loaning companies will also consider your existing debts. They prefer that only 36% or less of your income is spent on fixed expenses. You may be earning big but if you are also big on debts, the credit lenders will have to think twice.
Lenders also look into your other capitals in the form of stocks, mutual funds, collectibles and other assets. They can use these to cover for your debts if ever you fail to pay them back. If you do not have a good character and capacity to show, your last bet is a good capital for your loan request to be granted.
You will never know when you will need to get a loan to help you surpass a financial storm in your life. Be sure that you build up a good credit history by working on these 3 Cs.