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Spiritual_Jaguar4685 t1_ja8a05u wrote

Credit Scores are a number, between 300-850, that is used to measure how likely you are to pay back your debts.

In practice having a low credit score is an indicator that you are more likely to not pay your debts, and a high credit score indicates you are very reliable.

In turn lenders like banks and credit card companies will offer better (meaning lower cost) terms to people with high scores because they know it's a low risk of them losing money. They will offer worse terms (more expensive) to people with lower scores to offset the risk the person will not be able to pay them back.

The scores themselves are generated by private companies that don't disclose the math they use to generate them, but we know a little bit. Note that having no 'credit history' doesn't mean a poor score, it means no score. People who have never had any sort of loan or credit card at all have no score.

So to get a score in the first place you need some sort of loan, for example a credit card, and then start buying things and paying it off. The credit card company forwards your history to the credit score company and the credit score company takes note that you are borrowing money (using the credit card) and paying it off on time. This is "Good stuff" and gives you a good credit score.

For the bank question, no, not if you just have a checking account or savings account. BUT your credit score does factor in things like the size of your loans and the age of your accounts. For example if I have a massive car loan, and I pay it on time every month, the payment is a good thing (I'm reliable) but the size of the loan is a bad thing (I might not be able to pay other loans I get, because I already have a big one).

Other factors to consider are - people who look for loans need money and needing money is a good sign someone will have trouble paying loans, it's a Catch-22, but looking for loans will actually hurt your credit score for this reason. This is usually minimal and short-lived but it's important to know.

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Amazingawesomator t1_ja8almj wrote

Credit scores can now go above 800. I'm not sure when they changed that, tho.

Source: i just bought a car and had an 840 something.

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blablahblah t1_ja8u87o wrote

There's a bunch of different scores, some of them have different ranges. The standard FICO score ranges from 300-850, but there's a specialized FICO Bankcard score used for judging credit card applications that goes from 250 to 900. There's also separate scores for car loans and mortgages.

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astajaznan OP t1_ja8bryd wrote

Ok, lot of that I can understant to be important for a bank so thank You for making it more clear to me.

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whomp1970 t1_ja8bgnr wrote

ELI5

You go ask your next door neighbor to borrow $20 to fill up your gas tank to get to work. You've lived next to your neighbor for 10 years, and he knows you're pretty responsible, so he lends you the money. He trusts you.

But you find yourself short on gas next week too, and you don't want to bug your neighbor again, so you ask the mailman. Now, the mailman doesn't know anything about you, so he's got no reason to trust you.

But you tell the mailman, "Hey, go talk to my neighbor, he knows me really well, and I've paid him back many times, he'll tell you that you can trust me".

And so the mailman does this, and now he trusts you to repay the money.

It's the same thing on a bigger scale. You have a credit card. You pay your amount off every month, you never carry a balance. If you open a second credit card, the first credit card can now VOUCH for you. They will say "astajaznan pays off every month, he's trustworthy with money".

The same is true with car loans. If you pay your monthly payment every month without issue, then the bank will VOUCH for you if you want to get another car loan down the road.

The same is true for mortgages. And other lines of credit (where you are given money up front, with the expectation you pay it back).

If you're behind on some car payments, that lowers your trustworthiness. If you are always at your credit limit on your credit card, that lowers your trustworthiness.

Banks look at your trustworthiness to determine whether to loan you more money. Banks look at your trustworthiness to determine what interest rate you will have to pay when repaying a mortgage.

So ALL these institutions (car loan bank, credit card, mortgage bank) release all their information about your trustworthiness, to some central catalog. The central catalog keeps track of everyone's trustworthiness.

The central catalog has to "rate" your trustworthiness. You could do it on a scale of 1-10, or one to four stars, but they chose some other rating, that goes up to like 800.

That rating, that single number, is your credit score.

Now all banks have a easy way to tell, from a single number, whether it's risky to loan you money.

YES, PEOPLE, it's a lot more complicated than that. But this is ELI5, and this gets the job done.

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astajaznan OP t1_ja8cevh wrote

You really did get the job done! Thank You! I see now the logic behind the credit score way better.

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whomp1970 t1_ja8d9mn wrote

Thanks.

Try not to make guesses about how it works, though. Some of the decisions that go into your credit score might seem backwards.

I mean, some stuff, like "pay off all loans on time" is a no-brainer. But "how many credit cards I hold" and "how often I use my credit cards" doesn't always have an intuitive answer.

In other words, it's complicated.

If you want to know exactly what goes into your credit score, you have to do more digging.

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astajaznan OP t1_ja8ev9b wrote

Yes, we do not have that in my country, but I expect we will in future. We are 20-30 years behind America. I understand equation is not simple as "i use credit card = good". It's how it's used.

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whomp1970 t1_ja8fb3o wrote

That makes me curious: How do banks in your country decide whether or not to loan you money? What criteria goes into their decision?

There must be some kind of record of your past financial history, right?

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astajaznan OP t1_ja8hjz9 wrote

Yes. If you want a credit card, you must have an indefinite contract at work so that they can be sure that you have enough funds to pay it off. The amount of the allowed minus is usually 2-3 monthly salaries. As for the loan: also an indefinite contract. The amount depends on the salary, the monthly installment cannot exceed, I think, more than 1/3 of the salary. For some loans, you need a deposit or proof that you have the ability to repay such a large loan (usually proof of ownership of real estate or perhaps shares). And housing loans are most often taken out with a mortgage. You "give" the apartment you buy on credit as a cover for the loan you use to buy that apartment. When you pay off the loan, the apartment is 1/1 yours. That's how we bought an apartment... that is, we are in the process of buying it. We haven't paid all of it yet. People who are employed in government companies are the best candidates since it is very difficult to get fired there. So bank is sure you are going to be able to pay. Credit cards and shopping cards follow the principle of a permanent order (lietral translation). The bank collects its installment automatically every month until it's all paid out. You don't have an option where you don't pay, unless you don't have funds in the account, but usually payments are made from the current account - the one on which your salary is deposited.

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astajaznan OP t1_ja8htmj wrote

Also, I am not aware we have somethinhg similar to credit score company. Maybe our tax office does some mediation in this sense.

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bulksalty t1_ja8k9f6 wrote

How easy is it for an individual to file bankruptcy in your country? Does your country have liquidation bankruptcy (where debtors can get nothing if a borrower has no assets)? How hard is it to collect on a defaulted debt? How easy is it to set up and collect a wage garnishment?

Lenders want to know a lot more about how likely people are to pay them back with there are legal ways for them to not be repaid.

Since you mentioned the Balkans, I found a source indicating Croatia (to use as an example) didn't have any legal means of personal bankruptcy. In the US, almost 2% of the population went through a personal bankruptcy last year (many of those bankruptcies likely resulted in most of those borrower's debts uncollectable). Credit scores are going to be a lot less important if there's no legal way for a borrower to not pay their debts.

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astajaznan OP t1_ja8m8t0 wrote

I am not familiar with the way a person can file for bankrupcy but I found the article from Croatia that describes it. Same policy is, I believe, in all ex-Yu countres. You can translate it, sinc I'm not to "financial lliterate", to translate it in my own words. https://www.tportal.hr/biznis/clanak/zaglibili-ste-ovo-morate-znati-o-osobnom-bankrotu-20160812 I know that if company files for the bancrupcy, the founder of the company can not open new company on his/her name for next 5 years.

As I understand, when signing the contract with the bank for loan, both parties have to present evidence they have something to back up the loan. For bank that is not hard to present, and for person, in my case, is apartment we live in. The bigger the loan you ask for, the richer you have to be in order to support it. I don't know how it goes with a non-purpose loan. The bank will probably foreclose if you don't pay, or in the case of a loan with a guarantor, if you don't pay - the guarantor is obliged to repay your loan.

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TehWildMan_ t1_ja893os wrote

The general idea of a credit score is that is a numerical summary of a person's credit history.

Credit cards are among the easier ways to establish a revolving line of credit without any additional spending, so they're often discussed as ways to do exactly that.

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astajaznan OP t1_ja8a2qy wrote

What I noticed on various memes, etc., is that the more you use your credit card, the more your credit score increases. If you want to take out a loan from the bank, the higher the credit score, the better chance you have of getting a loan. Aren't people who use credit cards a lot more risky to the bank, in the sense that they might not have enough funds to repay the loan if they spend a lot? What's the catch, since I can't understand the principle?

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whomp1970 t1_ja8brqs wrote

The calculation of your credit score is quite complicated, and some of the decisions are not entirely sensible.

But think of it this way: If you use your credit card a lot, and you keep making the required payments, that makes you more trustworthy. If you NEVER use your card, then you never have an opportunity to "pay on time" (because you never charged anything), so they really can't tell if you're trustworthy or not.

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TehWildMan_ t1_ja8abof wrote

> Aren't people who use credit cards a lot more risky to the bank, in the sense that they might not have enough fund

Look at it another way, a person who for years has been able to handle having a few hundred dollars in revolving accounts, and never missed a payment, would appear as a lower risk than someone who has never had any kind of loan before.

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astajaznan OP t1_ja8aymr wrote

I assume you are from America. In our country (in the Balkans), a completely different logic prevails. Although I believe that this principle will come to life in our country at some point, since we follow the trends, and America is always light years ahead of us.

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Bensemus t1_ja9l0is wrote

Using the credit card responsibly looks good to the bank. However you can also use it poorly which looks bad to the bank. So just having a credit card isn't enough. They look at how you are using it.

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ayeeflo51 t1_ja89n28 wrote

Think of credit score as the ranking creditors give you, the higher the number, the more they trust that you will be able to pay that back.

A few categories make up how it is calculated such as your payment history (are you making payments on time), utilization (say you have a credit card with $1k limit, using 95% of that is bad), overall lines of credit.

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astajaznan OP t1_ja8al2m wrote

Yes, I somewhat understand. But isn't someone who doesn't use credit cards and manages to cover all their expenses with their income the safest for the bank?

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m4gpi t1_ja8eo4q wrote

The “safest” for the bank IS the person who is unreliable. The fees for no-, late-, or under-payments (and interest) all go to the bank. So really the ideal customer is someone who uses a lot of their credit, and isn’t the best at repaying under the agreed terms. What they really want is someone who makes occasional or frequent mistakes, but at least tries to keep up.

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ayeeflo51 t1_ja8fti6 wrote

What the other guy said is sorta right, the bank DOES want the person who is going to be unreliable, but being unreliable is what leads to a bad credit score.

Having a good credit score is what allows you to get more credit and better offerings which you can use to get free money or travel miles

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m4gpi t1_ja8krmo wrote

Yes I should have added that. A little credit, good utilization, and a healthy credit score go a long way (at least in the US) towards financial freedom. They are good tools in the game of money.

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Bensemus t1_ja9n4c7 wrote

Credit cards just seem to be used fundamentally different in your country.

In Western countries it's expected that adults will have at least one credit card. So many things can be tied to that card. A big one is automatic bill payments. Not all can be tied to your bank account. So when you go to apply for a mortgage the bank is expecting you to already have a credit history. If you use your credit cards right it means you never miss a payment. Even better if you don't carry a large balance on them. The bank will see your payment history and can see how much of the credit card you are using. It then uses this info as part of its calculation on what kind of mortgage it's willing to offer you.

If you don't have a credit card the bank has no history to use in it's calculation. It has no idea how good or bad you are with other people's money. It's still possible to get a loan or mortgage without a credit history but it's harder. The bank will relay way more on the other information you give so often you will need a much better job or more assets for them to be confident that you will pay them back.

Having a credit card doesn't mean you are bad with money on its own. It's entirely based on how you use it. Normally when you first get a credit card it might be a secured one. These have very low limits and you need to pay into them before spending money. These are designed for people with no or poor credit to build up a good history. Once you have a history or a better one you should move to an unsecured card. This is what people think of when talking about credit cards. These have larger limits and you get a bill every month showing what you owe, your minimum payment, etc. To maintain a good score you don't need to fully pay off the balance. You need to make at least your minimum payment and it's good to maintain a low level of utilization. This means that if your limit is 10k, your balance is say 3.5k or maybe up to 5k. If you maintain a balance near 10k this is noted in your history. Some people really overreact to high utilization. It will make it harder to get more loans but it doesn't really lower your score. It more pauses it while you pay down the balance. However regardless of whether or not it's affecting your score is the fact that that balance is costing you a ton in interest. Bank loans usually have pretty low interest while credit cards are often 3-5 times higher.

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blipsman t1_ja8c5rm wrote

It's a way for lenders to quickly assess your creditworthiness so they can make a decision whether to lend you money, how much, and at what interest rate.

It's based on factors from your credit report, such as length of credit history; types of credit/loans (do you have a history with credit cards, car loans, mortgages, etc); credit utilization (how much of your credit cards' allowable balance limit is filled); any negative actions/comments (bankruptcies, account charge offs/negotiated settlements, car reposessions, home foreclosures, etc.); number of accounts you have; recent hard credit pulls (could indicate other loan in-process or recently set up beyond what's reported on credit report).

In the past, lenders reviewed the reports, but there were individual biases, subjective criteria used by different loan officers, and it took time to read through pages of documents. By using an algorithm to spit out a more standardize score between 300-850, lenders can usually make instant decisions to approve you for a credit card, car loan or such and with what kind of interest rate.

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someone76543 t1_ja8xz1f wrote

In what country?

The details are very different in the UK and USA.

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astajaznan OP t1_ja93d9x wrote

I did not know UK had it to. What it is like in UK?

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someone76543 t1_ja994wd wrote

The UK doesn't have a central credit score.

There are central "Credit Reference" companies that record your credit history. Your bank reports that information to them.

The banks can then get that information and use it to calculate their own credit score for you. Each bank probably uses a slightly different scoring system.

Generally the credit reference companies will report:

  • What loans and credit cards you have
  • how much you owe on each account
  • For each account, each month, whether you paid on time, how late you paid, or if you didn't pay at all. For the last 2 years.
  • If you have a joint account with someone then they will report their finances too. Since if they get into financial difficulty that will probably affect your ability to repay too.
  • If you are taken to court for non-payment, or declare bankruptcy, that will be reported for many years (maybe 7 years? Never applied to me so I'm not sure the exact duration)

You can get a copy of your own credit report for a nominal fee. (£2, about $2).

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BigUT t1_ja8z6wt wrote

It shows your ability to pay back debt you didn't need to take on, with money you already had.

It has nothing to do with managing your money well, it's the supidest shit.

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Bensemus t1_ja9nbxs wrote

> It has nothing to do with managing your money well, it's the supidest shit.

But it does. Getting into CC debt shows poor money management skills. Having access to credit and using it well shows you are trust worthy and institutions will be willing to lend you more money at cheaper rates.

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BigUT t1_jadugzf wrote

If I have the money on my account, why do I need to borrow it to show I can pay it back and am "trust worthy". If you have enough money in the bank and use it well and don't get in debt, doesn't it show that you are trust worthy? No you have to get in debt to show you can pay back debt.

The thing is that credit system is built so that you're forced to use it to show that you are reliable instead of it being something you have access to and can use every now and then.

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Ok_Rhubarb2161 t1_ja9tgs5 wrote

BY THE WAY, everytime you apply for a credit card or loan, your score will go down. Im not adding to explanation i just wanted to add that fun little fact in

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Ferocious_Armadillo t1_jaa3wt2 wrote

I heard a great explanation of this recently on the news. It’s a number that (taking a bunch of other things into account like payment history for bills including mortgage, loans, etc, credit history (mainly think “how long have I had and used a credit card) and other factors into 1 number from 300-800. This number tells people “how likely am I to pay back credit?/how good of a borrower am I? (From a bank’s perspective$” the higher the number, the “better” of a borrower you are.

This is important and you should care because those with higher credit scores:

  • can get lower interest rates when you go to get a mortgage
  • would actually qualify for higher loan amounts/can borrow more money, and a bunch of other stuff.
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