Your credit rating, or your credit score, is like a report card - only the subjects are your finances and your dog cannot just eat it up. It also tends to stick with you for a long time. It is basically the ‘credit worthiness’ of a person, a business, or a country. It is an assessment of whether an entity would be able to pay back a loan or not. Nowadays, some employers may also use it to consider an applicant’s eligibility for a job. Leasing deposits and adjustment of insurance premiums are also affected by it.
A person with a poor credit rating is often more likely to experience higher interest rates. It may also be one reason for denying them a loan because the high chances of their being not able to pay it back and thus, defaulting.
Credit ratings can be categorised into three types:
1. Personal or Individual Credit Ratings
2. Corporate Credit Ratings
3. Sovereign Credit Ratings
It may then be further branched into short term and long term credit rating. Short term rating involves ratings for a person who might become a defaulter within a year and long term refers to an assessment of a person’s credit over a long period of time.
Calculations for credit rating involve assessment of the financial history of the person or company in question, and also the assets and liabilities of same.
Personal credit ratings are calculated by Credit Reference Agencies, also known as Credit Rating Agencies. Usually, the three-digit credit score analysis (the FICO score) is used. FICO (Fair Isaacs Corporation) is the first company that came out with credit rating calculation software. This analysis is offered by independent financial service companies. In Canada, the “R” ratings are most commonly used. These have a range from R0 to R9, with R0 being the best credit rating and R9 the worst. The factors that might affect a person’s credit rating are debt, lifestyle, interest, amount of credit used and savings.
Corporations may require a credit rating so that investors backing their debt security can analyse the risk involved. Corporate credit ratings are also assigned by credit rating agencies.
A country, a sovereign body, is also a candidate for credit ratings which indicate the potential for investing in it and the risks involved with such an investment. It also reflects the country’s ability to pay back its sovereign debts. These are the Sovereign Credit Ratings. These take into account several factors like economic risk, political stability etc. As of March, 2008, Luxembourg has the best sovereign rating and is considered to be the least risk investment possibility in the whole world.
Ricardo Reeves is an expert in debt management and has helped hundreds of families free themselves from a stranglehold of debt.
