What is Credit Score?

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Credit score - what an omnipresent word!

As you step into the world of credit, you will find the term 'credit score' on every avenue you explore. That itself must have conveyed to you how important a factor it is in the finance world. Your credit score decides whether you are eligible for a new line of credit. It tells the lenders how likely you are of paying your bills on time.

A good credit score is a key to good credit health. Read on to know more.

What is Your Credit Score?

What is Credit Score?

Your credit score is a number (ranging between 300 and 900) that tells how worthy you are of getting credit. Lenders use your credit score to evaluate whether you will repay your debts or not. A high credit score will make you an appropriate candidate in the eyes of the lenders, whereas a low credit score will be a hindrance on your path to getting credit.

A quick and amusing fact: to build your credit score, you must take credit, you must open a variety of accounts, you must be active in the credit market.

A person with no loans or credit cards will end up with a poor Credit Score.

You cannot calculate your credit score by yourself. Credit bureaus like Equifax, Experian and TransUnion evaluate your entire financial history and use a fact-based mathematical algorithm to calculate your credit score. The number of accounts you have, your credit history, your payment history, the inquiries you make, etc. - everything you do in the financial world impacts your credit score.

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What Affects Your Credit Score?

While each credit bureau has its unique way of calculating your credit score, these factors are unanimously considered by all.

  1. Your Payment History

    This is the most important credit scoring factor. A long history of timely payments is the best for your credit score. Missing a payment could be a disaster. Late payments are equally worse. However, once you start making timely payments and reduce the amount owed, the impact on your scores reduces over time.

    Make payments on time for all your accounts - not just your credit card bills but your rent, utility bills and even your cell phone bill. Don't drive any of your accounts into delinquency. Don't get into debt. Clear off all existing debt. As you do so, your credit utilization rate will drop and give a boost to your credit score.

  2. Your Credit Usage

    Credit utilization is another important factor that you can easily alter to improve or hurt your credit health. You should keep your credit utilization ratio within 30%. It shows that you are keeping your expenses within limits by using a small amount of credit. If you notice that your expenses are exceeding 30% of your credit limit, your credit scores will inevitably drop. The Credit Utilization ratio in each of your credit cards is taken into account by the credit bureaus to determine your credit score - individually as well as collectively.

    A high rate of credit utilization indicates that you are overspending and might not be able to pay your bills on time. Maxing out your credit cards or keeping outstanding balance increases your utilization rate and brings down your credit score. Paying the balance in full each month positively impacts your credit score. If your credit utilization rate tends to shoot up, you should try to balance it by making multiple payments each month. Reduce your credit utilization rate as much as possible - preferably below 30%, which is considered healthy for your credit score.

  3. Age of Your Credit History

    Credit age is important for your credit score. It shows how long you have been managing credit. You will be considered more worthy of getting credit if you can prove that you have been maintaining your credits responsibly for a longer period. Opening new accounts could also reduce your average credit age, which may hurt your scores a bit. To sum it up, avoid closing your oldest Credit Card account and think strategically before opening new accounts. These factors can bring down your credit score.

  4. Credit Mix

    Credit Mix refers to the number of credit cards or loans or mortgages that you have. A variety of accounts is always preferable as it shows that you have been trusted with credit by other lenders. It adds points to your credit score. However, don't start randomly applying for multiple credit cards. Credit mix is a minor factor for your credit score. More importantly, credit applications always lead to a hard inquiry. Frequent hard inquiries within a short period show your desperation and bring down your credit score.

  5. Hard Inquiry

    When you apply for a new line of credit, the lenders conduct a check on your credit report. This is known as a hard inquiry. Hard inquiries deduct points from your credit score. If you apply for too many credit accounts, each will amount to a hard inquiry. These hard inquiries remain on your credit report for quite some time. Many hard inquiries at a time will not only reduce your credit score but will also make you seem too desperate for cash. Lenders will not be able to trust you. So whenever you apply for credit cards, spread the applications apart over a long period.

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To Sum Up

Now that you know how important credit scores are for your overall financial health, you must ensure that yours are in great shape. Keep a check on your credit report at all times to understand your mistakes and work upon them accordingly.

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