Credit Score : How to Improve your Credit Score?

What is Credit Score?

A credit score is a numerical expression of the creditworthiness of a person. It is a rating that represents the ability of an individual to pay off their financial commitment or debt. Lenders and financial institutions use a person’s credit score to assess the risk of extending credit to a person. The credit score is calculated based on factors like credit accounts, payment history, outstanding debts, length of credit history, and recent credit applications of a person. Certain credit reporting agencies namely, TransUnion CIBIL, Equifax, Experian, and CRIF High Mark rate the creditworthiness of the people by assigning credit scores. It is believed higher the credit score, the better the creditworthiness.

Geeky Takeaways:

• A credit score is a numerical value that represents the creditworthiness of a person. Here, creditworthiness means the ability of a person to repay the debts or loan on time.
• A credit score is expressed in numbers. It is a three-digit number typically ranging from 300 to 900, with a higher score indicating better creditworthiness.
• Factors that impact the credit score of any individual include credit accounts, payment history, outstanding debts, length of credit history, and recent credit applications of that individual.
• Credit score benefits both the parties, the lender as well as the borrower. Lenders, use credit scores to judge the creditworthiness of the borrower and calculate the risk of lending money. On the other hand, a borrower with a high credit score enjoys better interest rates and more favorable terms on loans and credit products.

How Credit Score Works?

The credit score essentially, measures, how likely a person is to repay borrowed money. The following points help us to get an overview of how credit scores work:

1. Credit Bureaus: There are Credit Rating Agencies that gather information about an individual’s credit activities from different creditors, banks, and financial institutions. In India, there are four Credit Bureaus, Credit Information Bureau India Limited (CIBIL), CRIF High Mark, Equifax, and Experian.

2. Credit Report and Scoring Models: After gathering all the relevant information, credit rating agencies prepare a credit report of a person indicating details such as credit accounts, payment history, outstanding debts, length of credit history, and any public records (bankruptcies) and use credit scoring models, such as FICO (Fair Isaac Corporation) or VantageScore to calculate credit score. Under different models, different weights are assigned to different factors based on their impact on creditworthiness that helps in calculating the credit score.

3. Credit Score Range: In India, CIBIL is considered the most prominent agency that rates credit scores in a range between 300-900. Higher the credit score, the better the creditworthiness of a person. Generally, a credit score of 700 or more is considered good. however, lenders have their own range of judging the creditworthiness of a borrower.

4. Use of Credit Score: Credit score helps lender to judge the creditworthiness of the client and to calculate the risk of offering loan. On the other hand, client with good credit score enjoys lower rate of interest and favourable credit conditions.

5. Regular Monitoring: Individuals are suggested to monitor their credit scores regularly to check the errors make necessary improvements, and ensure the accuracy of the information on their credit reports.

How Credit Score is Calculated?

A specific calculation of credit score has not been revealed by the agencies, however, FICO and VantageScore are two widely used credit models. Credit models use various factors to calculate the credit score by assigning weightage to each such factors as explained below:

1. Payment History (35%): Payment history reflects the record of the repayment of the credit account. This considers on-time payments, late payments, defaults, or bankruptcies. On-time payments increase the credit score while defaults or late payments adversely affect the score.

2. Credit Utilization (30%): Credit utilization shows the ratio of current credit card balances to the credit limits of a person. The lower this ratio is better the score.

3. Length of Credit History (15%): This factor reflects a period for which credit accounts have been active. A longer credit history has a positive impact on the credit score.

4. Types of Credit in Use (10%): Credit Mix is a factor that counts in the variety of credit accounts a person has including credit cards, installment loans, and mortgages. A mixture of various types of credits has a positive impact on credit scores.

5. New Credit (10%): New credit considers recent credit applications. Too many recent applications for loans may harm the credit score as it shows the risky behavior of the borrower.

Factors Affecting Credit Score

These factors have positive and negative effects on credit scores. This can be understood as follows:

1. Payment History: Payment History reflects the repayment habits of a person and the duration of repayment of the loan by a person,i.e., whether a person repays the credits on time or late or falls under a category of a deflator.

• Positive Impact: On-time payments for credit cards, loans, and other credit accounts increase the credit score.
• Negative Impact: Late payments, defaults, bankruptcies, or other negative marks indicating a failure of repayment adversely affect the score.

2. Credit Utilisation: Credit Utilization reflects the amount of credit being used about the amount of credit available.

• Positive Impact: Maintaining a low ratio of credit card balance to a credit limit is considered favorable.
• Negative Impact: High credit card balances compared to credit limits may reflect financial strain.

3. Length of Credit History: This factor considers the duration for which credit accounts have been active.

• Positive Impact: A longer credit history generally reflects more experience managing credit and creates a positive impact on credit score.
• Negative Impact: Limited credit history is not considered good in this field.

4. Credit Mix: Credit Mix shows the combination of various types of credit (credit cards, installment loans, and mortgages) used by a person.

• Positive Impact: A mixture of credit cards, installment loans, and mortgages, may be viewed positively.
• Negative Impact: Limited variety in the types of credit utilized may have an adverse impact.

5. New Credit: New credits show the recent applications made for credit.

• Positive Impact: Responsible management of new credit accounts and a few applications may have a positive impact.
• Negative Impact: Opening multiple new credit accounts in a short period can be seen as risky behavior and can be considered negative.

6. Public Records and Collections: Public records like bankruptcies or tax liens are considered to calculate the credit score.

• Negative Impact: Bankruptcies, tax liens, and accounts in collections can significantly harm credit scores.

7. Financial Behavior and Debt Management: The behavior and financial habits of a person are considered under this factor.

• Positive Impact: Responsible financial behavior, including paying bills on time and managing debt wisely increases the credit score.
• Negative Impact: Frequent late payments, high levels of debt, and other signs of financial instability.

8. Credit Report Accuracy: Credit Reports prepared by the credit agencies may reflect inaccurate data. One shall keep monitoring the credit report timely.

• Positive Impact: Ensuring the accuracy of credit reports and addressing any errors promptly helps to improve credit scores.
• Negative Impact: Inaccurate information on credit reports can unfairly impact credit scores.

How can I Check and Monitor my Credit?

Credit Monitoring is an act of keeping track of credit activities that have an impact on the credit score. You can easily monitor your credit by:

1. Monitoring Credit Bills: Tracking and monitoring credit card bills and other credit bills at regular intervals helps you avoid late repayments, identifying frauds, unauthorized purchases, or identity theft. All this mayhurtn the credit score.

2. Obtaining Credit Report: In India, the Reserve Bank of India (RBI) has made it mandatory for all credit agencies to offer one free credit report to its clients every year. You can ask for your free copy from these agencies and can examine the accuracy of the report. The credit report also helps you in understanding the calculation of your credit score. You can also use various apps to know your credit score timely.

3. Awareness: You should be aware of fraud and the security of your information. Setting up fraud alerts and credit freezes can help you keep your credit account safe and avoid unauthorized or fraudulent activities.

How to Improve Your Credit Score?

You can improve your credit scores by applying the following strategies:

1. On-time Payment: You should always try to repay your credit card bills and other credits on time to have a good creditworthiness that ultimately increases your credit score.

2. Reduce Credit Card Balances: You should aim to keep your credit card balances low about your credit limits. High credit card balances can negatively affect your credit utilization ratio.

3. Accuracy of Credit Report: You should be aware of your right to obtain one free copy of your credit report every year and shall keep track of your credit report through apps and soft copies to ascertain the accuracy of the information presented by credit agencies in your credit report.

4. Avoiding too Many New Accounts: You should avoid applying for credit too frequently and to too many creditors. This shows your desperate behavior and may reflect the risk of lending. Limiting new credit applications helps you to improve your credit score.

5. Diversifying Credit Mix: You should always aim to use various credit types such as credit cards and installment loans as it reflects your financial and debt management ability. This creates a positive perception in the mind of the lender.

6. Maintain Older Credit Accounts: The duration of your credit account also affects your credit score. Try keeping an older credit account as it has a positive impact on credit history.

Frequently Asked Questions (FAQs)

1. What is a credit score?

Answer:

A credit score is a numerical expression of three-digits that shows the creditworthinessof an individual. Credit score help lenders to calculate the risk of extending cresit to that individual.

2. What is a good credit score?

Answer:

In India CIBIL is the pst prominent credit agency that rates the credit score between a range of 300 to 900, however, a credit score of 700 or above is consideredgood. The cutoffs may vary among lenders.

3. How can I check my credit score?

Answer:

You can check your credit score through free credit reports provided by credit bureaus, credit monitoring services, online apps, or through financial institutions that offer credit score access.

4. How often should I check my credit score?

Answer:

It’s advisable to check your credit score atleast once a year. However, more frequent monitoring is suggested if you’re planning a major financial decision, can be beneficial.

5. How can I improve a low credit score?

Answer:

To improve your credit score your should develop a responsible financial behavior, such as paying bills on time, reducing credit card balances, and addressing any negative items on your credit report