What is a Credit Score?
Credit Score – A Credit Score is a score or a number that depicts the creditworthiness of a person based on his/her credit history and other aspects. In general, credit score lies between 300 to 850 and is the crucial factor for people to acquire loans. When a person has a higher credit score, he/she would be likely to secure a loan from a borrower.
Almost all lenders consider the credit score before they can allow an individual to borrow money, whether it is a credit card or a personal loan. A good credit score would be around 600 or above that. When you have a credit score in that range, you have better chances of being approved for loans.
The concept of credit score was created by ‘Fair Isaac Corporation’, which is also called ‘FICO’, and most of the financial institutions rely on the credit score that has been provided by FICO. There is an availability of other credit scoring systems, yet, most people or financial institutions go for the score provided by FICO.
More than 800: excellent
740 to 799: very good
670 to 739: good
580 to 669: fair
Less than 580: poor
How do they work? – The scoring model of FICO (or any other credit scoring model) allows an individual to generate a credit score with the help of an automated process. Going through a person’s entire credit report would take up a lot of time, and lenders must make use of a lot of time and effort for an individual. To make this process easy, the concept of credit score was created.
When a lender looks at your application containing the entire credit report, there is a possibility of misjudging the information and making errors, which can be avoided with credit scores.
The credit score of a person keeps changing over time when that person makes payments toward the loans obtained and the creditors update this information. These updated scores are obtained from the credit bureau, which updates the score on the credit scoring models. Depending on the credit reporting agency, the credit information might differ. The main reason for this is the credit information that has been updated and uploaded on the scoring model.
How is it calculated? – In the United States, there are 3 major credit reporting agencies namely Experian, Equifax, and Transunion. These 3 credit reporting agencies are responsible for the reports, updates, and storage of an individual’s credit history. Even though there are certain types of differences in the information that has been collected by these bureaus, the process of calculating the credit score remains the same, which is as follows.
- Payment history
- Total due amount
- Length of credit history
- Types of credit
- New credit
Payment history is responsible for 35% of the credit score and represents the information whether a person makes timely payments or not.
The total due amount, that an individual owes, is responsible for another 30% while calculating the credit score. The total due amount is also an important factor in determining the credit utilization of a person. Credit utilization is helpful in knowing the credit limit available to a person, and the percentage of credit that is being utilized.
15% of the credit score is based on the length of the credit history. People having longer credit histories and preferred by lenders as these types of people are considered less risky. Lenders can also obtain a lot of information regarding the payment history from the length of credit history.
The type of credit is responsible for 10% of the credit score. This is also helpful in knowing about the types of loans that the person has already secured such as car loans, mortgages, etc. Upon obtaining that data, lenders can estimate whether the person has more installment credit (such as personal loans) or revolving credit (such as credit cards).
New credit is responsible for the last 10% of the credit score by considering the information about the number of new accounts to which the individual has applied. This information represents credit inquiries and the time when the last account was opened.
How to improve credit score? – Credit scores are created to anticipate an individual’s ability to make timely payments. It is no wonder to say that making late payments would affect the credit history and result in a lower credit score. There are some other factors like these that impact the credit score of a person. So, let’s discuss the things we have to do to improve our credit score.
- Pay bills on time:
As discussed above, late payments will have a negative impact on the credit score of an individual. Therefore, it is highly suggested that a person should opt for making payments on time.
- Increase the credit line:
If you have accounts such as credit cards, you should call the respective issuer and ask whether you qualify for an increase in the credit limit. It is not for borrowing more money, instead, it is for increasing credit utilization which would result in an increase in the credit score.
- Don’t close your account:
Even when you are not utilizing a credit account, it is highly suggested that you should not close that account. This would certainly have a negative effect on your credit score. Why? Let us see an example.
Imagine that you have a loan of $1,000 and a credit card limit of $5,000. Then the credit utilization would generally be around 20% and this is good. However, if you close the credit card account, your credit utilization would become 40%, which is considered to result in a decrease in your credit score.
- Opt for credit repair companies:
Credit repair companies would improve your credit score by contacting creditors as well as the credit reporting agencies in favor of you. For this, they usually charge fees.
Bottom line – Credit score is very important which might result in spending or saving a lot of money depending on your credit history. A good credit score can help you in getting loans at lower interest rates, while a bad credit score might result in difficulty while acquiring a loan. Therefore, it is highly recommended that you take care of your credit score and monitor it regularly.