Are you or your company creditworthy? Often times, individuals or companies seek to acquire credit, when this happens, they are assessed by their credit quality. Here, let me bring you a detailed description of the term credit quality and how important it is.
What is Credit Quality?
Simply put, credit quality is the ability to repay debt. It is a measure of an individual or company’s creditworthiness.
It is a bond issuer’s ability to repay interest and principal in a timely fashion. Credit quality is depicted with a letter by rating agencies as AAA, AA, and so on. This means that the lower the rating, the higher the probability of default.
The reason behind this topic is to measure the likelihood of default, especially by a bond issuer. Credit rating agencies determine credit quality. This is done to provide bond ratings, they may change these from time to time. The credit quality of individuals is measured using FICO scores.
How Does it Work?
The credit quality of an individual is measured with the aid of a FICO score. The FICO score is designed and calculated by Fair Isaac Corporation. It is a mathematical summary of the information on an individual’s credit report. Bond ratings are measures of the credit quality of companies that issue bonds. These ratings can also be assigned to insurance companies or other entities or securities to indicate the level of risk.
FICO score comes in a range of 300 – 850. Now, the higher a person’s score, the more creditworthy the person is. The best interest rates are given to borrowers with FICO scores above 740, although, this is a generalized stand.
So many factors are considered by the FICO score algorithm in determining credit strength. They include payment history, the amount owed, the length of the person’s credit history. Other factors are; the amount of borrowing capacity, as well as, the types of debt used by the borrower.
The three major credit bureaus include Experian, TransUnion, and Equifax. Each of these credit bureaus collects information about a person’s credit quality. Thus, a person can have three different measures of credit quality. This score is free for some credit card users.
How Important?
Credit quality greatly impacts the amount of credit for which an individual or business gets approved. It also affects the interest rate he or she is required to pay for that credit.
Credit quality also influences the price and demand for certain bonds. This is because, the lower the credit quality, the riskier the investment. As a result, the less the investment is worth. Owing to this, downgrades (or rumors of downgrades) in an issuer’s credit rating can have a significant impact on its bonds. Also, on the market or industry.
On the whole, an individual or a company can improve its credit. This can be done by making on-time bills payment, getting current, and staying current on bills. Also, by keeping low debt balances, avoiding unnecessary credit. Also, by not opening lots of new credit accounts at a young age, making judicious use of credit accounts. Finally, regularly checking one’s credit report for errors.
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