The Effect of Interest by Credit Virgin
The loan process gets a little more complicated when a company is loaning money to lots of people because Companies expect to be paid interest in return for loaning people money. Let’s return to our analogy with John and his friends. Remember Mark, Luke and the random guy? When John gives his friends’ money they repay him the same amount and everyone is happy. However, if a company was loaning money to John’s friends, the company would expect to be paid back the original amount plus extra for interest.
Now, we’ll see what it would look like if a company were loaning money to John’s three friends. If a company is going to loan Mark money there’s a good chance they will get their money back, they know this because mark has a good credit score. So, the company can feel safe charging him a low interest rate because there is a high probability they will be re-paid.
On the other hand the company knows if they loan Luke money there’s a good chance they won’t get it back His poor credit score tells them he is risky to lend money to. So the company has two choices. One, don’t loan Luke money or two, loan him money, but charge him a really high interest rate because of the risk they are taking.
Finally we come to the stranger. The stranger is probably more responsible than Luke, but the company has no way of knowing this for sure. So, the stranger is probably going to be in about the same boat as Luke. The company either wouldn’t loan him money or they would charge him a high interest rate to make up for the risk they are taking. So hopefully now you can see why having a good credit score is so important. It basically labels you as a trust worthy person. It encourages people to loan you money and you’ll save tons of money because you won’t have to pay a high interest rates. In the next video, we’ll look at some real life examples of how your credit score can benefit your life.