Written By- Jaya Pathak
If you are dreaming of that shiny new car or cozy home in the future, your credit score could play a huge role. But what exactly is this credit score, let’s figure out. In this blog, we are going to develop an understanding about credit score and the factors which affect credit scores.
understanding credit scores
Think back to your school days. Remember the report that video scores mentioned in it. Well, just as your academic score showed how well you did in school, your credit Score reflects your financial performance. Our credit score is a three digit number that tells banks and other lenders how capable you are to repay your loans. Technically speaking, it tells the lenders the chances of you defaulting your loan. Higher the number, lower the chances of default.
Banks and other financial institutions use this number to decide whether you are alone worthy or not. In a nutshell school basically reflects how well you have managed your credit in the past and credit here means all types of loans – A personal loan, home loan, your credit cards or even the buy now pay later loans and so on.
A credit score is a portrait of someone’s credit history made-up of several factors.
How is credit score calculated?
There are these special companies called credit bureaus. These companies calculate your credit score using your financial data. But you might be wondering that how can these companies get your financial details! The Reserve Bank of India regulates these credit bureaus all lenders and credit card companies must compulsorily share information with them. They pass your basic details and loan related information like amount of loan taken, kind of loan, tenure, repayment, delays to special companies every 30 days.
These special companies collect and maintain all the loan related information for all the loans for all the borrowers. Based on it, the credit bureaus generate a credit report and a credit score for every borrower. Usually, credit bureaus look at last two to three years data the computer credit score. If you had defaulted 5, 7 or 10 years back, it won’t reflect in your credit score.
But don’t you think you can scape. All this information will be available in the credit report. So despite our wonderful credit score our bank may still reject your loan application on the basis of defaults in your distant past. So a good credit score Is essential. But a good repayment history is even more critical.There are four credit bureaus TransUnion CIBIL (oldest in the country), Experian, CRIF and Equifax.
Impact of good and bad credit score
Credit score can be in the range of 300 and 900. A score above 750 is considered a very good score by the lenders. It shows that you have always repaid your loans on time and just like a good academic score In school what get you a very good college very easily, a good credit score will help you to get new credit at lower interest rates. In fact several data says that 80% of the loans that get approved have a score above 750.
If you have a slightly lower credit score, say between 651 and 750, banks see you as an average borrower. You can get a loan but at higher interest rates. If your credit score is between 501 and 650, banks see you as a poor borrower with some defaults in the past period even if banks agree to lend to you, they will charge a very high interest rate. If you fall in the very poor borrower category with multiple defaults in the past, it will be very difficult for you to get a loan.
Why is it important to have a high credit score?
A high credit score will allow you to get loans at lower interest rates. As per your credit score if it lies above 750, it is considered as a very good score by banks and other lenders. It shows that you have repaid your loans on time and you can get credit at lower interest rates.
5 factors
Well there are multiple factors that can hold your credit score, we will look at the major ones:-
- Payment history: Payment history is the most important piece of your credit profile. It accounts for roughly 35% of your scores. If you have been responsible In the past, you can probably be trusted in future. So avoid late payments at all costs. It is given 35% weightage while calculating credit score. Even a single missed EMI can reduce your credit score by 60 to 70 points.
- credit utilization: Amounts owed or credit utilization as the second most important factor coming in at about 30% of your score. This part is important because notching a good credit score doesn’t mean that you don’t borrow. In fact not using your credit is almost worse than using tons of it.You want to show that you can handle a reasonable amount of depth without going off the rails. If you are eligible for a total credit of say ₹10,00,000 and you have consumed 5,00,000 in your credit cards, it means you have utilized 50% of the credit. A credit utilization of over 30% is seen as negative for your credit score.
- length of your credit history: One of the more obvious factors in our credit score is the length of your credit history which accounts for 15% of your number. It is like in those old movies where a shop you want to let’s one of his regulars run up a tab because he knows he’s good for it. Same goes with credit period the longer you have been borrowing, the better.
- Types of credit: Types of credit accounts 10%. It reviews how many sources of borrowing you use like a car loan, mortgage, credit card. The more diverse, the better.
- new credit: New credit accounts for 10%. It takes into account how often you take on credit you don’t need like applying for a credit card at five of your favourite new stores.
- Defaulting on loans: If you have defaulted on a loan in the past, your chances of getting fresh credit is almost 0 similarly settling the loan or credit card account instead of paying it in full can also hold your score.
- Errors in credit report: Sometimes there may be errors in your credit report that portray you as a higher credit risk than you actually are. It can negatively impact your credit score.
- Applying for a lot of credit quickly: If you inquire for multiple loans in a short time, it shows that you are credit hungry which can damage your credit score. In a nutshell inquiring multiple loans in a short time reduces your credit score.
