Credit score is a numerical value that reflects an individual’s credibility for meeting financial obligations. Lenders like banks and financial institutions use this number to assess default risk before approving a loan.
Insurance and mobile phone companies use this score to determine creditworthiness of their potential customers. This helps them in managing operational risk and forecasting revenue/profitability.
The credit score is obtained from reports issued by credit bureaus. These bureaus use a scoring model to calculate an individual’s credit score; they consider multiple factors in calculating a score.
Highlights – What do creditors look for?
- On time bill payments
- Mix of different types of credit (Credit cards, student loans, auto loans, lines of credit etc.)
- Lenders and creditors prefer borrowers with a low utilization rate
- Credit Utilization Ratio: Refers to the amount of revolving credit you’re using dividend by the the total amount of credit that you have available.
1. Payment history
Payment history shows your attitude and willingness towards meeting financial obligations. This gives creditors an idea about your money management skills and behavior with money. It’s expected that if you’ve successfully managed finance in past, you are more prone to do so in the future.
Payment history makes up 35% of the total credit score and tends to be the strongest predictor of your ability to make payments on time. Therefore, following accounts are normally considered for determining payment history,
- Payment for the credit card companies like Visa, Master, Discover, and American Express, etc.
- Retail shopping accounts like if you’ve obtained credit from departmental stores.
- Payment for the mortgage loans, student loans, lines of credit and auto loans.
- Any form of loan where regular payment needs to be made, like a car loan or some installments.
Credit Score – Public Records on Credit Report
In addition to the above, some events of public record can be quite serious. For instance, bankruptcies, lawsuits, and wage attachments adversely impact your credit report for multiple years.
Here are some tips to enhance your payment history, resulting in an improved credit score
- Make sure to pay your bills on a timely basis.
It’s the first step to be taken if you want to improve your credit score. Appropriate planning and budgeting can be effective ways to ensure all payments are made on time. However, making payments on time requires financial and mental discipline. Sometimes, it might mean sacrificing personal desires and paying bills in priority to gain financial credibility.
- Do not miss current payment deadlines.
Not missing the current payment deadline can help to repair your credit score. Past late payments have a negative impact; however, they vanish with time. So, timely payment for the current period can be a helpful measure.
- Get help from creditors/credit counselling services.
You might be able to negotiate improved terms with the creditors. For instance, you might request creditors to reduce the interest rate. So, instant payment can be made to improve/repair your credit score.
2. Length of Credit History
A long credit record leads to improved confidence in financial credibility of an individual. It helps to understand your experience of managing personal finances. It further helps understand if you are a responsible citizen who can manage credit in a responsible manner.
Higher the period you’ve been managing credit with a good attitude and on-time payments, the higher chance you have of maintaining a good credit score. Furthermore, the type of credit you’ve obtained is highly relevant for calculating a credit score. For instance, the impact can differ for the revolving and installment credit.
3. Amount Owed
Amount owned refers to total outstanding liabilities on your credit report. The amount owed is not directly linked with the credit score. However, if you have already utilized a higher percentage of available credit, it might signal higher risk to creditors.
The amount owed include total amount owed, types of accounts for the amount owed, number of accounts, number of accounts with balance, and credit utilization ratio on revolving accounts.
If credit utilization is near to max, it might adversely impact the credit score. However, not using any of the available credit may not be beneficial.
4. New Credit
New credit counts for 10% of your credit score. Below are three factors that impact new credit on a credit report.
- Number of inquiries – The number inquiries made for opening a credit account remain on a credit report for two years. Although, the impact of queries may not be as significant in the long run, it might make a small impact to a credit score.
- Number of new accounts – The number of credit accounts decreases average age per account. It’s considered a negative factor for the credit score. So, it’s not advisable to open new accounts on a frequent basis.
- Time of a recent account opening – Credit score considers opening a recent credit account. It’s because one may not handle multiple accounts at once.
Conclusion
Credit Worthiness
A credit score reflects the creditworthiness of said person. A higher credit score helps to negotiate favorable terms of a financial contract between consumers and creditors. As a result, this score is compiled by credit bureaus depending on five factors that include:
- Payment History
- Length of Credit History
- Amount Owing
- New Credit (Inquires)
- Credit Mix
- Credit Utilization
Establishing good credit history with creditors, lenders and financial institutions is important for your financial health. If you want to someday apply for a mortgage, auto loan, or small business loan, having good credit can increase confidence in lenders and save you money on interest in the long haul. Lenders, landlords and employers all use credit history to gauge the suitability of applicants. Furthermore, and maintaining good credit history can help separate you from the pack and give you a sense of financial awareness, accountability and peace of mind.
