You must have often heard about credit score and might have also read somewhere about how to maintain a good credit score and how to improve it. However, have you ever wondered how your credit score is determined? Which are the factors that are taken into consideration by credit information companies such as CIBIL, Equifax and Experian while calculating your credit score?
“A credit score (numeric summary derived from one’s repayment history) summarizes the historical credit information on a credit report by assigning a number to it. There are specific elements from one’s credit report that shape/ determine their credit scores,” says Mohan Jayaraman, Managing Director, Experian Credit Bureau, India.
These elements or factors include:
# Recency: Recent Credit Account Defaults
# Leverage: Credit Accounts with on-time re-payment history
# Coverage: Non-delinquent and delinquent Credit Accounts
# Delinquency Status: Defaults on Credit Accounts (current & recent periodic intervals)
# Credit Applications: Credit Account Applications over last 30 days
Typically the following rough weightages are considered in making up a credit bureau score:
Payment History (35%): Your payment history alone amounts to close to 35% of the total credit score. No need to say, it is extremely important to be consistent with the payment of your bills. Otherwise apart from paying fine for late payments, you will also end up ruining your credit history.
Total credit (30%): Even if the money owned by you is small, you should try to get rid of it because it comprises around 30% of the credit score. Minimization of outstanding debt helps improve one’s credit score.
Length of credit history (15%): The length of your credit history makes up almost 15% of the total credit score. Also, the period one has been using one’s credit has an important bearing on the score.
New credit (10%): The weightage of 10% is given to any new credit applied for. Therefore, you should think twice before applying for a loan or credit card.
Demographics (10%): Things like your age, location of your residence and the number of IDs (such as PAN card, voter ID, etc) you own also help determine your credit score. This comprises nearly 10% of one’s credit score.
It is, however, important to note that while some of these factors may be weighed more heavily than others, no one factor works independently of the others. In India, “the credit score typically ranges between 300 and 900. While the scores themselves may differ across the bureaus, typically a good credit score would be above 700. The actual cut offs for an acceptable credit score may vary across banks according to their risk appetite. A borrower should understand and evaluate all these factors to be able to build a good credit score,” informs Jayaraman.
An individual, therefore, must build a credit footprint that will let the banking system evaluate their creditworthiness. Mentioned below are some key pointers to be borne in mind to ensure a healthy credit score.
Review your credit report on a regular basis: When you make an application for a loan, credit card, mortgage or other type of credit, lenders look at your credit report and may use the information contained within it when making their decision. Therefore, “review your credit report regularly to make sure it’s up to date and accurately reflects your circumstances as mistakes can hurt your credit rating. A periodic review of the credit report can prepare an individual to be more financially responsible, plan finances better and also assess credibility before applying for new credit,” says Jayaraman.
It could also be of use in the following instances:
# To enable you to monitor your progress, if you are recovering from any past credit problems
# To provide an indication if you are a victim of identity theft
# To correct any information you feel is inaccurate in your existing report
Keep up with repayments and pay on time: The most important factor to improve a credit score is to clear all outstanding credit card dues and then start paying back outstanding on your loan regularly (month on month). Once a borrower has managed to pay all his outstanding EMIs and has started paying his loan EMIs regularly, his score will start improving.
Close unused accounts: Close unused credit accounts if you no longer require them. Lenders can take into account the credit limits available to you, and not just what you currently owe.
Space out credit applications: A lender will likely check and leave a credit application search footprint on your credit report each time you apply for credit. Space out your credit applications and limit making several applications close together as this could be a sign of financial stress to lenders.