Banks and lending institutions will check your credit score when you apply for any credit product. It is one of the most critical and indispensable metrics that determine whether or not you will get the loan.
Understanding the factors that affect your credit score is also important to maintain your financial health. Here, we will discuss these factors in detail and find all the possible implications they can have on your credit score.
Why is Your Credit Score so Important?
A credit score is a numerical representation of your creditworthiness, ranging from 300 to 900. It plays a crucial role in determining your eligibility for loans, credit cards, and even rental agreements.
A higher score indicates better creditworthiness, making it easier to secure financial products at favorable terms. It means that banks and financial institutions find you more creditworthy, that is, the risk of default is less if you are provided a loan or any other financial product.
Your credit score affects various aspects of your financial life:
Loan Approvals: Higher scores increase your chances of getting approved for loans.
Interest Rates: Better scores typically lead to lower interest rates on loans and credit cards.
Rental Agreements: Landlords often check credit scores to assess reliability.
Factors Affecting Your Credit Score
We’ve discussed the factors that impact your credit score quite comprehensively. They are:
- Payment History
Importance: Payment history is the most significant factor, accounting for about 35% of your credit score.
Details: This includes your record of paying bills on time. Late payments, defaults, and bankruptcies can severely damage your score
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When it comes to late payments, the farther they are, the worse their impact on your credit score. On the other hand, defaults and bankruptcies are a red signal to potential lenders.
Additionally, public records such as – charge-offs, debt settlements, foreclosures, lawsuits, wage garnishments or attachments, liens, or public judgments can severely damage your credit score and credit report.
If you wish to rebuild your credit score, you can start paying off your dues in time.
Tips: Always pay at least the minimum amount due on time. Setting up reminders or automatic payments can help ensure timely payments.
- Credit Utilization Ratio
Importance: This ratio makes up about 30% of your credit score.
Details: It is the percentage of your credit limit that you are currently using. A lower utilization ratio is better.
You might be making your loan repayments on time, but what if you are gradually reaching a breaking point with all the credit accumulated in your portfolio? Thus, the credit utilization ratio or debts owed is always better when it’s less.
Example: If you have a credit limit of Rs.1 Lakh and your current balance is Rs.20,000, your utilization ratio is 20%. It’s ideal to keep this ratio below 30%.
Tips: Pay down high balances and try to avoid using more than 30% of your available credit.
- Length of Credit History
Importance: This contributes about 15% to your credit score.
Details: It includes the age of your oldest credit account, the age of your newest account, and the average age of all your accounts. Longer credit histories are generally better.
When a person has a long credit history, potential lenders can assess the financial stability as well as finesse in credit risk management.
Example: A person with accounts that have been open for several years will typically have a higher score than someone with newly opened accounts.
Tips: Keep old accounts open to maintain a longer credit history.
- Credit Mix
Importance: Your credit mix accounts for about 10% of your credit score.
Details: This refers to the variety of credit accounts you have, such as credit cards, retail accounts, installment loans, and mortgages.
Example: Having a mix of a credit card, a car loan, and a mortgage can positively impact your score.
Tips: Aim for a diverse mix of credit types, including secured and unsecured. But only open new credit accounts when necessary.
- New Credit Inquiries
Importance: New credit inquiries contribute about 10% to your credit score.
Details: When you apply for new credit, lenders make a hard inquiry on your credit report. Multiple hard inquiries within a short period can lower your score temporarily.
This is because a high percentage of credit accounts represent a greater risk. Individuals or entities encountering cash flow problems often take multiple credits and some of them might not even be repaid on time.
Example: Applying for several credit cards in a short time frame can hurt your credit score.
Tips: Limit the number of new credit applications you make and only apply for new credit when necessary.
What Doesn’t Impact Your Credit Score?
Unlike a lot of misconceptions, the following factors don’t affect your credit scores:
- Age (although some credit bureaus consider applicant’s age)
- Marital status
- Ethnic factors like race, color, religion, and nationality
- Salary or income
- Employment or business history (however, some lenders might consider these)
- Address
- Child/family support obligations
- Payment of utility bills
- Any information that’s not included in your credit report.
Conclusion
Maintaining a healthy credit score requires a clear understanding of the factors that influence it. By managing your payment history, credit utilization, length of credit history, credit mix, and new credit inquiries, you can improve your credit score.
Regularly monitoring your credit report and making informed financial decisions will help you achieve and maintain a good credit score. You can track your credit score for free with Moneyview’s credit tracker and stay on top of your finances!
