Credit ratings are a way to measure the credit worthiness of a certain individual, corporation, country or other entity or business. It is a numerical value (or letter value) that is usually used by lenders or banks to judge what kind of risk is involved in loaning that entity money. It can also be used to measure the value of junk bonds or corporate debt; however, this is sometimes referred to as a bond rating.
Misconceptions
A credit rating is not just the score on your own credit report. Large companies and even entire countries are subjected to the same type of measuring instruments that you are. These ratings help other countries, banks and lenders decide if they can lend money to anyone. These credit ratings are not entirely affected by a failure to pay past debts. They take into account an entity's assets, income and their past financial history.
The Facts
An individual's credit score is called a FICO score, and it is a three-number score that was established by the Fair Isaac Corporation in the 1950s. This score is made up of several factors, including a person's income, their debt-to-credit ratio (how much debt they owe compared with how much credit they have been extended already) and the number of past-due accounts on their credit record. A corporation's credit score is determined by Standard and Poor's, a financial company that compiles ratings and financial information. This score is a letter score from A to D; three As is the highest score, and anything below a BBB is considered speculative.
History of
In the 1950s as people settled into urban jobs, companies began to issue credit as loans for homes, large appliances or cars--anything that cost more money than the average person kept in the a bank account. These companies saw that people would be able to pay for these large items over time, to make it easier for them, and they could charge interest in return for the favor of loaning them the money to pay upfront. However, the companies needed an easy way to assess the risk in loaning money to an individual. So, the Fair Isaac Corporation devised a complicated method of producing a score, based on income, credit history and assets.
Significance
Your credit rating determines whether or not a bank will loan you money for a car, home, credit cards or other large purchases. It will also determine the interest rate and terms you receive on these loans. When a bank sees a higher credit rating, they figure you are less of a risk and not as likely to default or miss your payments, which cost the bank money.
Benefits
A good credit rating allows you to take out a loan for a home or car or to open a business. It does not mean you will definitely pay the money back, but it does show you have a good history that says you are more likely to. Since banks and lenders earn money only when people are able to make their monthly loan payments on time, credit ratings allow banks to earn more money, handle less defaults and therefore lend out more money to those who need it. It also allows investors to more easily judge the risk in buying corporate bonds and prevents further losses on Wall Street.
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