Those intending to borrow money should understand the difference between a credit score and credit rating so they know the loans that suit their needs and financial situation. A credit score reflects an individual’s level of risk when borrowing money, whereas credit rating applies to elements like lending terms, interest rates, and maximum amount offered to borrowers. This article explains everything you need to know about credit score and credit rating to make an informed decision when applying for a loan.
Difference between credit score and credit rating
A credit score is a three-digit number that denotes the borrower’s creditworthiness. It tells a lender if the borrower is capable of repaying their loan based on their credit history and other factors. Credit scores range from 300 to 850 in South Africa, and individuals with higher scores have lower risk to lenders. In contrast, if you have a low credit score, it means you are a high-risk borrower, and your loan application can be rejected, or you will be charged high interest.
On the other hand, credit rating refers to the letter ratings applied to corporations and governments and used to determine the level of riskiness posed by investors. Lenders, investors, and other related players use credit ratings to assess the risk involved in investing or lending money to a certain corporation or government. For example, the symbol “AAA” is the highest rating, which denotes low credit risk, whereas the symbol “D” is the lowest rating showing high risk or chances of default. Credit ratings are based on opinions, and they do not guarantee performance.
Therefore, the main difference between the two is that a credit score is a number that expresses the creditworthiness of an individual borrower, and a credit rating is a letter that shows the creditworthiness of a corporation or government. Agencies such as Moody’s S & P, and Fitch provide credit ratings, and FICO primarily provides credit scores. The credit bureaus in South Africa including Experian, TransUnion, VeriCred, and Xpert Decision System (XDS) determine an individual’s credit rating.
When you want to apply for a credit card, mortgage, or auto loan, the lender will check your credit score to determine your eligibility for a loan based on the level of risk reflected. Investors interested in buying sovereign debt from a particular country will check its credit rating. Both credit scores and credit ratings are created by agencies and help show a borrower’s level of creditworthiness to lenders and creditors.
Why Are Your Credit Score and Credit Rating Important?
A credit score is important because it reflects the borrower’s likelihood of repaying the money borrowed. If you have a low credit score, your loan application is likely to be declined because the lender will consider you a high-risk borrower. Additionally, you may be charged high-interest rates by lenders if your loan application is approved due to your score.
On the other hand, a credit rating is crucial since it helps investors make informed investment decisions. A higher credit rating makes the investment lucrative because of the likelihood of lower risk involved. Banks also use credit ratings to make lending decisions to determine the potential borrower’s creditworthiness. An entity with a higher credit rating is likely to borrow money at a lower interest rate. However, it is difficult to get a favorable deal with a bad credit rating.
Credit ratings are created by independent agents and are often viewed as objective by market participants. They help the players involved make informed decisions when they decide to invest in global markets. Furthermore, credit ratings also play a critical role in determining the interest rate that can be charged to a specific government when it borrows. Countries with higher credit ratings can borrow at lower interest rates, whereas those with lower credit ratings are charged high-interest rates.
How Is Your Credit Rating or Score Determined?
The information on your credit report is used to determine your credit score, and it involves the following factors:
- Payment history: Your payment history accounts for 35% of your FICO score.
- Credit utilization: Your credit utilization contributes 30% of your FICO score.
- Credit history period: The length of your credit history accounts for 15% of your FICO score. A longer history is better for your overall credit score.
- Types of credits: Different types of credit accounts you have contribute 10% of your FICO score.
- New credit: New credit accounts constitute 10% of your FICO score.
Apart from FICO, the other scoring model that can be utilized is the Vantage Score.
On the other hand, the credit rating agency is responsible for determining an entity’s credit rating. Credit rating agencies use both qualitative and quantitative analysis to determine the credit rating of a particular entity. The process involves analyzing different types of qualitative data including financial statements, balance sheets, income statements, and cash flow statements. Quantitative analysis involves the examination of non-financial information about the corporation, such as industry trends, management team, and overall economic conditions and performance. Credit ratings are subject to change over time.
What Are the Two Types of Credit Rating?
Credit ratings are classified into two categories including investment grade ratings and speculative grade ratings. Investment grade ratings involve solid investments that are less priced because of the likelihood of the issuer honoring the terms of investment. On the other hand, speculative-grade investments come with high-interest rates because of the high risk involved.
Understanding the difference between a credit score and a credit rating is vital since it helps lenders determine the borrowers’ creditworthiness. High-risk borrowers usually receive high-interest rates. If you know your credit score, you can make an informed decision before you apply for a loan. With a high credit score, you are likely to get the best loan deal with a lower interest rate and acceptable repayment terms. When your score is bad, your application may be rejected, or you will be charged high interest because of the potential risk you pose to the lender.
