Credit Score: How is it calculated and what factors influence it?

A credit score is a three-digit number that helps lenders assess your eligibility for loans or credit cards. This score is calculated by credit bureaus based on your credit history, as mentioned in your credit report. Hence, it is extremely important that you maintain a healthy credit score to get faster approvals and deals as per your requirements.

It is interesting to note that credit score is calculated based on various factors which help the lenders understand whether or not you are capable of repaying the loan on time or not. Let us have a look:

Factors affecting credit score calculation

Payment history: Your payment record is the record of loans and credit accounts like credit card, personal loans, home loans and others. It contains details of missed or late payment, bankruptcies, and your payment behaviour in repayment of existing debts.

Credit score evaluates parameters such as, time of payment, the amount of pay, and how often the payment has been missed. Since payment history shows how creditworthy you are, it is one of the critical factors for computation of your credit score.

Credit utilisation ratio: Your Credit utilisation ratio plays an important role for determining the credit score. This is the percentage derived from using credit divided by total credit limit availed by you. The higher this ratio is set to more than 30%, it reduces your credit score. If you want to boost your credit score or at least to avoid its deterioration it’s better to use not more than 30-40% of your total credit limit.

Total number of accounts: The number and types of credits you have affects your score, including the number of credit cards you have. Different types of credits like home loan, personal loan as well as credit cards increases your credit score. Thus, the number of accounts you have is an important criteria in determining your credit score.

Credit mix: Your loan portfolio mix of secured and unsecured credit will affect your credit score. Loans that include collateral are considered to be secured loans whereas the ones without collateral are called unsecured. Secured loans have a comparatively lesser impact on your credit score due to the collateral involved. However, any defaults on repayment will impact your credit score and will be marked negatively in your credit report.

Credit inquiries: Multiple credit applications can be perceived by lenders as having a desperation, or that you make extensive use of credit, and this will give lenders a reason not to approve your applications. Hence, a hard inquiry should be done only when you are completely sure that you are in need of a loan.

On the other hand if you wish to know your credit score then you should consider a soft inquiry which will not do any harm to your credit score.

Credit score ranges

Credit scores typically range from a minimum score of 300 to a maximum of 900. Let us have a closer look at these scores.

4 key tips to improve your credit score

You must understand that a credit score can not be increased overnight and requires consistency and discipline. With constant efforts and regularity, you will be able to increase your credit score gradually. Now, let us discuss some tips through which you can significantly improve your credit score:

Timely payments: Make sure that you always repay your personal loan EMIs and credit card balances on time. Ensuring that you pay before the due date reflects a strong image of financial responsibility and improves credit rating. A single missed payment will take a heavy toll on the credit score.

Pay full credit card bills: Avoid paying your credit card bill in the minimum amount. It is advisable that you pay the entire amount of the balance each month. This not only makes you avoid high interest charges but also increases your credit worthiness.

Limit credit usage: Avoid exhausting credit cards to the maximum limit. You should avoid exceeding the limit by more than 30-40%. This may reflect excessive credit dependency and impact your credit score. Hence, it is better to keep a very low credit utilisation ratio.

Avoid over-borrowing: These include credit cards or taking large amounts of loans, the two can easily make you fall into a debt trap. Only borrow the amount which you are able to repay without any financial pressure.

In conclusion, it is important to remember that any type of credit involves risks. It is advisable to have an understanding of your financial capability before applying for any credit and stick to the amount you really require. With this, you can make an informed decision and save yourself from debt traps and deteriorating your credit score.