A credit score is an indicator of a person’s creditworthiness, or their ability to repay debt. These scores are categorized into different brackets and these brackets each tell us the ability of a person to repay his debt.
Did you know that if you’d want to apply for a loan from a bank or would want to issue a credit card, the first thing the bank or the financial institution checks is your Credit Score.
If you don’t have a credit history yet and are wondering why it’s important to build a Credit Score, here’s why!
There are four credit bureaus which check and build Credit Scores.
- CIBIL TransUnion
Banks and non banking financial institutions sends our report to these credit bureaus on a monthly basis. Based on these reports, these credit bureaus build our Credit Score.
A few of the main factors that are considered by the credit bureaus to calculate and build your Credit Score are:
Payment History: This happens to be one of the main factors to build or make your credit score. Paying your credit card bills on-time builds up a good credit score. But, not paying your EMIs or credit card bills on-time, i.e after the due date will have a very bad impact on your credit score.
Always try to pay the total outstanding due instead of paying the minimum amount due as the minimum amount due happens to be a trap set by credit card companies. You may notice that even though you’re paying the minimum amount due for months, the bill never gets cleared, this is because of the high interest rates which keeps on getting added to the bill.
Credit Utilization Ratio: The percentage of the amount you spend on your credit limit of your credit card is called CUR. (In the below formula, CC means Credit Card.)
Here’s a quick formula to calculate your CUR:
Note: One should always try and keep the CUR around or if possible below the 30% mark.
Age of Credit: Let’s assume there’s person ‘A’ who has issued a credit card 10 years ago and person ‘B’ who has issued a credit card 2 years ago. Both of them pay their credit card bills on-time. Now, if both of them were to approach a bank to get a loan, the bank would easily choose person ‘A’ as his credit experience is better. This is because he has maintained an excellent credit score for a much longer period than person ‘B’.
Conclusion: The longer the credit age, the better it is for your credit report.
Types of Accounts: There are two types of accounts, i.e, secured and unsecured credit accounts. Let’s say you have a home loan, the bank will not give you your legal documents of the home until you pay your home loan completely. This type of account falls under secured credit. Issuing a credit card against Fixed Deposit also falls under the same category. Now, let’s say, you’ve been offered a personal loan or been offered a pre-approved credit card. These accounts fall under unsecured credit. It’s always best to have both types of account, i.e secured credit and unsecured credit account in your credit report.
P.S: You’ll only be offered an unsecured credit account if you’ve a very good or an excellent credit score.
Negative status account: Let’s say you have borrowed a loan from a bank and you couldn’t pay-off the debt due to some financial hardships. You approach the bank and quote them a settlement price, if the bank agrees to make a final settlement, they accept the offer and close the account. This leaves a negative impact on your credit report.
Hard Inquiry: Everytime you apply for a loan or a credit card, a hard inquiry is noted on your credit report by the bank you apply for a credit account. Having too many hard inquiries in a very less amount of time leaves a bad impact on your credit score.
Credit Report: A credit score is just an overview of your credit report. The credit report contains all the factors which decide your credit score. Few of the main factors which decide your credit score are Payment History, Credit Utilization Ratio, Age of Credit, Types of Accounts, Negative status account, Hard Inquiry and so on…
Banks and financial institutions not only check your credit score provided by the credit bureaus but also follow a detailed credit report check which includes all the above mentioned factors.
Advantages of having a great credit score:
- Low Interest Rates on Credit Cards and Loans.
- Better Chance for Credit Card and Loan Approval.
- More Negotiating Power on interest rates.
- Get Approved for Higher Limits.
- Easier Approval for Rental Houses and Apartments.
- Better Car Insurance Rates.
- Avoid Security Deposits on Utilities.
- Bragging Rights (That’s right! You can BRAG about it!)
- 0 : Nil, Nada - I still haven’t built the score
- 300 - 549 : Bad Score
- 550 - 649 : Average Score
- 650 - 750 : Good Score
- 750 - 850 : Excellent Score