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How Important Is Credit Risk Ratio?

May 22, 2008
Every one knows how FICO or the Fair Isaac Corporation scoring systems work. There are however many other types of systems employed by lending companies when computing one's credit worthiness. But whatever credit risk system your lender uses, it is important to always keep a close eye on your credit risk ratio.

Credit risk ratio is the percentage or the likelihood that lenders will lose because of a borrower's inability to pay on time. Or, in other words, it is the odds that banks, lending institutions, or credit card companies will say "NO" to your credit applications.

A credit risk ratio is not a factor; rather, it is a result of your credit performance. Just like what was mentioned earlier, the FICO has its own way of scoring one's credit worthiness or the ability to pay for his credit obligations. The mathematical formula is secret least likely disclosed, though FICO reveals the factors that may spell difference between being a credit worthy and credit risky borrower.

The first factor is the promptness of your payment. That makes up thirty five percent of your total FICO score. The earlier you pay the bills, the better. Also, you need to know that FICO puts more focus on your recent bills, although your past late payments will also reflect on your present report. More importantly, a credit card account that has been handed over to collecting agencies will definitely hurt your credit score. If you're not doing well in this 35-percent factor, then you are basically raising your credit risk ratio.

The other factor is the debt to credit ratio. This accounts for thirty percent of your total FICO score. This rating is obtained by dividing your credit utilization over the total credit limits. For instance, if a person has total credit limits of $80,000, and he used $60,000, then his debt to credit ratio is 75%. An ideal percentage should fall between fifty to sixty percent. Making it above sixty increases your chances of becoming a credit risky borrower.

The third factor is the length of credit history. This is fifteen percent of your credit score. Credit scorers like FICO are not mindful of how long you have owed money from someone, but they are more interested in your relationship with your lender. If you have used your credit and stayed with the same credit card company for that long, that makes you more as a credit worthy borrower.

Ten percent of the remaining twenty percent is based on the combination of credit types you use. Basically, there is the consumer finance, revolving, an example is credit card, and installment. If you vary your credit types, you have a big chance of reversing your credit risk ratio.

The other ten percent comes from your resourcefulness. FICO awards a full ten percent to borrowers who are confident to look around for the best interest rates.

Interestingly though, your FICO score will not guarantee you of having a complete credit worthy status. Take for example, a person's current employment or income status. Even if he has gained an attractive FICO score, but presently has no means of earning income, he will still be labeled a credit risk borrower. That person's credit applications will most probably still be denied. High credit risk ratio is not something you would want to earn, so be extra watchful when you use your credit cards.
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