What is credit score?
There are no surprises here! Your credit score is one of the most significant measures of your creditworthiness. It is a three-digit number generally ranging from 300 to 850, calculated based on certain metrics. The higher your credit score, the less risky you seem to the potential lenders or creditors. The calculation of a credit score is based on various factors, however, the impact of every factor may vary. Credit Bazaar provides you information on the several factors included in the credit score calculation that explained in detail as follows:
- Payment history: This aspect that goes into the generation of your credit score takes into account whether you have paid the dues on your credit accounts on time and constantly. It is a factor having the highest impact on credit score generation. If you have been consistent in paying your loan EMIs/bills, it proposes that you are a responsible debtor and are at a lesser risk of defaulting. An accountable credit behavior will also make you qualified for quicker approval on your applications and privileged rates on loans. Missing payments, making late payments, etc. will lessen your credit score by quite a few points. It also puts other facets into consideration such as delinquencies, collections, and bankruptcies. It also takes into contemplation the size of these problems, the time period is taken for resolving it, and how long the problem has stayed after surfacing. Your credit score will be low if there are payment issues in your credit history. Therefore, if you have 15 credit accounts, and you’ve had a late payment on 5 of those accounts, that credit utilization proportion may impact credit scores. Principally, when a creditor or lender takes a look at your credit report, the prime criteria they are trying to figure out is if they extend the credit of this person, will he/she be able to pay it back on time. They observe how you have repaid your past credit. The other various facts that may be included in your payment history are auto loans, installment loans, retail department store accounts, credit cards, student loans, mortgage loans, home equity loans, and finance company accounts. The payment history also comprises details on foreclosures, wage attachments and any accounts that have been reported to collection bureaus. Overall, the section of payment history has the biggest impact on the calculation of credit scores and almost all credit score models will study all of this information.
- Credit utilisation ratio: This is a factor having a high impact on the credit score as the usage of credit is the second biggest element that affects your credit score. A credit utilization ratio is basically the total amount of credit you have used in relation to the cumulative total credit limit accessible to you. The calculation of the credit utilization ratio is executed by dividing your overall outstanding balance by your total credit limit. According to specialists, customers should ideally use only 30-40% of the credit limit for maintaining a high credit score.
- Hard inquiries: Primarily, hard inquiries take place when the creditors and lenders check your credit as a response to credit or personal loan application. When there a great number of hard inquiries, your credit score can be impacted adversely. On the other hand, if you are planning to go for a mortgage loan, a new utility provider or shopping for a new auto, several inquiries are usually counted as one inquiry for a specific period of time. Based on the credit score model, the period of time may differ, but it’s characteristically from 14 to 45 days.
- Available credit vs. Used credit: This is also a significant factor included in the generation of credit score. The creditors and lenders pay special attention to see if you are able to use credit responsibly and regularly pay it off. If you have a blend of credit accounts that are climaxed or at their border, that may impact credit scores.
- Types of credit used: The calculation of credit score considers the various types of credit accounts held by you, comprising installment loans (such as mortgages, auto loans, home equity loans, student loans, and personal loans) and revolving debt (such as credit cards). Moreover, another important aspect is how many of every type of account do you possess. Creditors and lenders prefer individuals that are able to multi-task and successfully manage several credit accounts of multiple types. The credit score models also reflect this behavior.
- New credit: The calculation of a credit score may also take into consideration how many new credit accounts are opened by you lately. These new accounts have the ability to impact the length of your credit history. Furthermore, when people apply for credit frequently, it perhaps specifies financial burdens, so every time you apply for credit, your score gets simulated a little. The important thing to remember here is that if you open numerous credit accounts in a small period of time, it indicates a higher risk, particularly for people who do not have a very long credit history. If it can be avoided, it is better that you do not open so many accounts in such a hasty manner.
- Length of credit history: This particular section of your credit history provides details about how long the various credit accounts have been active. The calculation of a credit score may take into consideration the length of your recent and oldest accounts, precisely how long it has been since they have opened. Basically, the creditors want to see that you have a good history of paying off your credit accounts responsibly. Based on this, they can predict that you will be making timely and accurate payments in the future too. The longer your credit accounts have been open and in good standing, the healthier is the credit score. According to common sense, anybody will perceive that a person who has never made a late payment in 25 years is a safer option than somebody who has been on time for only three years.
- Amount owed: The next biggest constituent if the amount you currently owe as compared to the available with you. This is a crucial factor that will be considered by your lender will be the credit score and is of utmost priority and prominence. The formula to calculate credit score makes an assumption that the borrowers who continuously spend up to or above their credit limit capacity are prospective risks. Usually, the lenders also like to see the credit utilization ratio, which refers to the percentage of credit available that you actually use, which is below 20%. This particular constituent of credit score is focused on your present amount of debt. It also considers the various different accounts that are opened in your name and the particular types of accounts held by you. A huge total amount of debt from distinct sources will adversely affect your credit score.
- Total accounts: This particular factor has a comparatively low impact on your overall credit score calculation. However, it is crucial to maintain a decent balance of unsecured as well as secured credit. A home loan or car loan are examples of secured credit whereas a credit card is a sample of unsecured credit. A good credit mix helps in boosting your credit score. Though the impact of this factor as compared to other aspects is less, you should not ignore it at any cost. The total accounts you have indicates your experience in handling both the credit types. One should avoid borrowing only one single credit type in large quantities as it could hinder your credit score.
- Age of the credit: For a better assessment of your creditworthiness, your history with credit is also considered when computing your score. This criterion has a medium impact on the calculation of your credit score. If you have handled your credit in an answerable manner in the past and continue to service payments on time on your active credit lines, it will absolutely affect your credit score. A long credit history helps creditors or lenders take a rational decision on whether to offer you credit or not. Hence, it is directed to keep credit cards with a long history open compared to cards you have recently attained.
- Taxes: Although taxes do not affect your credit score directly, the manner in which you decide to pay them and if paid off late, the credit score is affected. The calculation of your credit score will be influenced if you do not pay your taxes on time or negotiate an installment agreement with the IRS. In such a way, the taxes can derail your credit.
- Other payments: Generally, your utility payments or rent will only show up on your credit reports, when they have gone bad. Since, in case of evaluating your credit score, bad debts are measured which gives a clear picture of your credit behavior. It is usually in the form of a collection or a judgment if you owe money. There are various bureaus such as Experian that let the property managers and landlords report rental history for helping the renters to build credit. Similar is done for other bank transactions and utility bills.
What isn’t included
It is crucial for a person to understand that your credit score is only a reflection of the information confined in your credit report. In its assessment, your lender or creditor may consider other information as well. For instance, your credit report does not even show the length of your employment or your current income. Though, your credit score is a prime instrument used by lending bureaus. It is imperative that you keep a keen eye on your credit report. That is the basis of your credit score, so revising it at least once a year and amending any errors on it is critical. Broadly, the following factors are not included in the calculation of your credit score:
- The color, race, national origin, religion, marital status and sex of a person is not considered while calculating the credit score. These facts should not change the credit score calculation. In many countries such as the US, the law prohibits the credit score to be based on these facts.
- Usually, the age of a person is not considered while calculation a credit score. Moreover, the location where a person lives also does influence credit scoring.
- Very old credit information such as a charged-off credit account, a collection account more than seven years old, or a bankruptcy that is more than 10 years old will not impact your credit score or will not be listed on your credit report.
- The interest rate that is being charged on a particular account or a specific credit card is not considered. Also, rental agreements or items that are reported as family/child support obligations are not used for measuring of the score.
- Consumer-initiated inquiries, or soft inquiries, fundamentally refer to the inquiries that you have made for checking your credit score. These do not appear on your report. The promotional inquiries for pre-approval of the credit card offer that was made for reviewing your credit account by the lenders or creditors, will also not show up on your report.
- On a whole, if a particular facet does not forecast your credit behavior, it is not going to be included in the calculation of credit score. So, a piece of information that has not been proven to predict the future credit behavior of the person, is not counted in the credit score computation.
Conclusion: The credit bureaus design their scoring formula usually in a non-discriminatory and fairest possible manner. Therefore, as long as you handle your financial obligations responsible and pay your bills on time, your credit will reflect the same, irrespective of how much money you make or how old you are. Credit Bazaar offers overall assistance in calculation of your credit score and provides you a Free Credit Report. Contact us today to get to know your credit score and credit report.
For any queries regarding Credit Score improvement or Loan contact Credit Bazaar CR Arcade 2nd Floor, Opposite Delta Garden, Next to Shree Mahalaxmi Restaurant, Mira Road East, Thane: 401107