What Are the Benefits of Credit Ratings?

A credit rating can be the deciding factor on whether a borrower does or does not receive a loan. Good credit ratings allow people, companies, and governments to easily borrow from financial institutions or public debt markets. At the consumer level, banks will usually base the terms of a loan as a function of a credit rating or credit score; this typically means that the better your credit rating, the better the terms of the loan. On the other hand, if your credit rating is poor, the bank may even reject your request for a loan. This can impact your ability to obtain a mortgage or a credit card. Businesses and governments can benefit from high credit ratings as well.

Personal Credit Ratings

Credit scores are determined by credit reporting agencieswhich are companies that collect consumer credit information and sell it to lenders to help determine a borrower’s credit worthiness. There are three major credit agencies in the United States:

The credit bureaus assign credit scores based on a borrower’s history of taking out loans, overall loan balances, and payment history.

If a person has a track record of paying back loans in a timely manner, that individual will probably have a high score. Low credit scores are assigned to people that have a history of making late payments or defaulting on loans. High levels of debt can also decrease an individual’s credit score. For that reason, it is important to check your credit score often and pay down any outstanding debt or resolve any issues impacting your credit score so that it can start to increase once again.

Personal credit ratings, or credit scores, range from 300 to 850. 670 and up is considered to be good, while 740 to 799 is considered to be very good. A poor credit score would be anything lower than 580.

Corporate Credit

At the corporate level, it is usually in the best interest of a company to look for a credit rating agency to rate its debt. Investors oftentimes base part of their decision to buy a corporation’s bonds, or even the stock, on the credit rating of the company’s debt.

Major credit agencies, such as Moody’s, Fitch Ratings, or Standard and Poor’sperform this rating service for a fee. While Moody’s and Standard and Poor’s are located in the U.S. and control approximately 80% of the ratings market, Fitch is located in more than 30 countries and controls approximately 15% of the ratings market.

Investors often look at the credit rating given by these international agencies as well as ratings given by domestic rating agencies before deciding to invest. The demarcation line for corporate credit rating is investment grade. Investment grade and above are considered to be less risky, while below investment grade carries more risk but sometimes more reward, particularly through higher yields on bonds.

Government Ratings

Credit ratings are also important at the country level. Many countries rely on foreign investors to purchase their debt, and these investors rely heavily on the credit ratings given by the credit agencies. Benefits of a high credit rating include being able to access funds from outside their country and the ability to attract other forms of financing to a country, such as foreign direct investment.

A company looking to open a factory in a particular country may first look at the country’s credit rating to assess its stability before deciding to invest. For example, Treasury bills from the United States are considered to be low risk because they carry the credit rating of the United States government. Because the U.S. is a country with a strong economy and low political risk, its credit rating benefits because of these factors.