Our financial lives are significantly impacted by credit scores. They affect our ability to borrow money, the interest rates we’re offered, and even our ability to rent an apartment or get a job. Despite their significance, many people are confused about what credit scores are, how they’re calculated, and how to improve them. In this article, we’ll explain everything you need to know about credit scores, from what they are to how you can boost yours.
Table of Contents
What is a Credit Score?
Your creditworthiness is represented by a three-digit number, known as a credit score. Lenders, landlords, and other financial institutions use your credit score to evaluate your ability to repay debts. Your credit score can range from 300 to 850, with higher scores indicating better creditworthiness.
There are several credit scoring models, but the most widely used is the FICO score, which was created by the Fair Isaac Corporation. FICO scores are used by most lenders in the United States, and they’re based on information in your credit reports from the three major credit bureaus: Equifax, Experian, and TransUnion.
How is a Credit Score Calculated?
There are several credit scoring models in use today, but the most widely used is the FICO score. The FICO score was developed by Fair Isaac Corporation and is used by most lenders in the United States.
The FICO score is calculated using a complex algorithm that takes into account various factors from the person’s credit report. These factors are weighted based on their importance, and the resulting score is used by lenders to determine the person’s creditworthiness.
The factors that are used to calculate the FICO score are:
- Payment History (35% of the score)
Determining a person’s credit score relies heavily on their payment history, making it the most critical factor. It measures how often the person has made their payments on time and how many times they have missed payments. Late payments, collections, bankruptcies, and foreclosures can all negatively impact a person’s payment history.
- Credit Utilization (30% of the score)
Credit utilization measures how much of a person’s available credit they are currently using. It is calculated by dividing the person’s total credit card balances by their total credit card limits. When a person has a high credit utilization ratio, it may suggest that they are overextended and could have difficulties paying off their debts.
- Length of Credit History (15% of the score)
Length of credit history measures how long the person has had credit accounts open. A longer credit history is generally seen as a positive factor because it shows that the person has a proven track record of managing credit responsibly.
- Types of Credit Used (10% of the score)
Types of credit used refers to the different types of credit accounts that the person has, such as credit cards, loans, and mortgages. Having a mix of different types of credit can be beneficial because it shows that the person can manage different types of credit responsibly.
- New Credit Accounts (10% of the score)
New credit accounts measure how many new credit accounts the person has opened recently. Opening multiple new accounts in a short period can indicate that the person is overextended and may have difficulty making their payments.
In India, credit scores are calculated by credit bureaus such as CIBIL, Equifax, Experian, and CRIF High Mark. The CIBIL score is the credit score that is widely utilized and it has a range of 300 to 900. The credit score is calculated based on the individual’s credit report, which contains information about their credit history.
Tips for Improving Your Credit Score
Improving your credit score takes time, but there are several things you can do to boost your score.
- Pay Your Bills on Time
As we mentioned earlier, your payment history is the most critical factor in determining your credit score. Late payments, delinquencies, and defaults can all have a significant impact on your credit score. To avoid these negative marks, make sure you pay your bills on time every month. If you have trouble remembering to make payments, set up automatic payments or reminders.
The amount of debt you owe makes up 30% of your credit score. If you have a high credit utilization ratio, meaning you’re using a lot of your available credit, it can indicate that you’re overextended and may have trouble paying your debts. To reduce your debt, try to pay more than the minimum payment each month, and consider using the debt snowball or debt avalanche method to pay off your debts faster.
The debt snowball method involves paying off your debts in order from smallest to largest, while the debt avalanche method involves paying off your debts in order from highest interest rate to lowest. Both methods can be effective, so choose the one that works best for you.
- Keep Your Credit Utilization Ratio Low
To keep your credit utilization ratio low, try to use no more than 30% of your available credit. For example, if you have a credit card with a $10,000 limit, try to use no more than $3,000 of that limit. If you do need to use more of your available credit, try to pay it off as soon as possible.
- Keep Old Credit Accounts Open
Keeping your old credit accounts open is crucial because the duration of your credit history accounts for 15% of your credit score. Even if you don’t use a credit card anymore, keeping it open can help you maintain a long credit history and improve your credit score.
- Apply for Credit Sparingly
New credit inquiries make up 10% of your credit score, so it’s important to avoid applying for credit too often. When you apply for credit, it can result in a hard inquiry on your credit report, which can lower your credit score. Try to apply for credit only when you need it and avoid applying for multiple credit accounts within a short period.
- Check Your Credit Report Regularly
It’s important to check your credit report regularly to ensure that all the information is accurate. You’re entitled to one free credit report per year from each of the three major credit bureaus, so take advantage of this and check your report for errors. In case you come across any inaccuracies in your credit report, it is advisable to promptly notify the credit bureau.
Can You Improve Your Credit Score Quickly?
Improving your credit score takes time and effort, but there are some things you can do to see results more quickly. For example, you can:
- Pay down your debts: Paying down your debts can help you improve your credit utilization ratio, which can have a positive impact on your credit score.
- Dispute errors on your credit report: If you find errors on your credit report, you can dispute them with the credit bureau to have them corrected or removed.
- Become an authorized user: If you have a friend or family member with a good credit score, you may be able to become an authorized user on one of their credit accounts. This can help you improve your credit score by adding positive payment history to your credit report.
- Use a credit repair service: Credit repair services can help you identify errors on your credit report, dispute them with the credit bureau, and improve your credit score.
Conclusion
Understanding credit scores is essential for managing your finances and achieving your financial goals. Your credit score reflects your creditworthiness, and it’s used by lenders, landlords, and other financial institutions to evaluate your ability to repay debts. To improve your credit score, focus on paying your bills on time, reducing your debt, keeping your credit utilization ratio low, maintaining a long credit history, avoiding new credit inquiries, and checking your credit report regularly. Adopting these recommendations can assist you in boosting your credit score and attaining your financial objectives.