As the world got more systematic and organized in various aspects of life, a system known as credit scoring and rating was introduced into the financial sector and this gained popularity in the 1980s. Credit scoring evaluated a person's lifestyle, earnings, and expenditure and estimated quite accurately how much of a financial risk the person was. This helped banks and other lenders of money to determine whether or not a person was worthy of a loan and what their chances were of recovering the loan.
Credit scores and reports reflect how you have managed your finances over time. It maps the borrowing as well as payment patterns and reflect debt trends. Bad scores stem from not paying credit card bills, mortgage payments, or loan EMIs in time or non payment of dues. Bad credit scores also result from mistakes made by a spouse if you have ajoint banking account or have taken loans in joint names.
In general credit scores range from 300-800 and the higher the score the better off you are. Credit rating agencies use algorithms to determine credit scores and reports. Credit scores depend on variants like: bill payment regularities, borrowings from different sources, loans gone sour, the frequency of availing loans and extent of borrowings. They also study your credit usage, whether you have taken auto loans, home loans, credit card loans, and so on.
Presently, all over the world, credit scoring is the basis for:
o Sanctioning loans, housing, personal, or vehicle. A lending institution will give loans faster to people with good credit scores. This protects the institution's investment and ensures return.
o Setting interest rates. The better the score the lower the interest rates.
o Sanction of credit or debit cards. Consumers with excellent credit report and scores receive cards without delay and the cards have better credit limits and lower interest rates.
o Renting a home or office. Property owners are more agreeable to renting out space to people they consider reliable. A credit score and report establishes without doubt a person's reliability and standing in society.
o Credit scores even affect insurance. Those who are credit worthy are favored by insurance companies with great premium rates and offers.
There are major credit scoring organizations like FICO and it is important to keep an eye on your personal credit score and report periodically to ensure that an excellent score is maintained. Poor credit history means a low credit score and this means you are considered a risk and it reflect on you as a person.
According to financial professionals it is important to inculcate 'money management' concepts and the habit of planning finances from when kids are young. This will help them be reliable citizens when they grow up and live a life free of debt and bankruptcy.
In the US in September 2006 there were 32, 585 cases of bankruptcy filed. And the US agencies are making great efforts to spread awareness of financial planning and debt in order to reduce bankruptcy rates.