What Are The Factors That Affect Credit Score?
What are the factors that determine the credit scores?
When one is eligible for loans, credit cards, mortgages, and other kinds of credit, financing, lenders, creditors, and financial institutions take into account the most important factors a credit score represents. Those with strong credit normally find it simpler to get approved, and most of the time they are given better terms like reduced interest rates. Likewise, bad credit makes one unable to borrow or pay a high cost of borrowing.
Five factors determine credit score and each of them has a different weight.
Payment History (35% Weightage)
Payment history is one of the most crucial components, which impacts 35% of your credit score. It proves that you have been able to meet your previous financial obligations concerning debts and bills. Each payment is recorded, and lower numbers mean bad pay habits such as missing, delaying, or inconsistent payments while higher numbers represent good pay behaviors, which entail paying on time and without any defaults. So ensure you clear all your EMIs, credit card bills, utility bills, etc before the due date every month. A 30-day delay can reduce scores by over 100 points.
This component has a 30% weightage and is measured by the credit utilization ratio.
The credit utilization ratio determines the amount of available revolving credit you are using at any one time out of your total credit limit. For example, let you have three credit cards, the total limit of which is Rs. 30000, and the outstanding amount on all three cards is Rs. 15000 then your credit utilization ratio is 50%. It is suggested that this ratio should not exceed 30 percent. Credit utilization above 80-90 percent of the total limits available is considered risky and decreases your score while credit utilization of 10-30 percent results in high scores that are considered to be excellent.
Credit Mix (10% weightage)
Having a mix of credit cards as well as installment credit such as personal loans, home, and auto loans is important because lenders like to see that one is capable of managing credit of both kinds responsibly. Therefore having a healthy blend of such accounts as well as ensuring that all the payments are made on time assists in building the scores rather than just having one type of credit account. However, negative marks in one account can negate a positive track record in another.
Credit history length (15% weightage)
It is also important that the longer your credit history and the longer you have had those accounts, the better it is for your credit score. It proves you have been using the credit responsibly for decades and paying your bills on time. Normally, you would require six months of active credit history to obtain a FICO score. Many lenders also consider credit history while approving loan applications, and they usually desire individuals with at least 2-3 years of credit history. Closing of some long-standing cards can be detrimental to this factor.
New Credit Applications (Weighted Total = 10 percent)
If you apply for one or the other credit like a credit card or loan, then several applications are noted in your credit history. Recent application frequency also impacts scores heavily, as it may signal credit greed and risk. It is recommended to avoid applying for new credit more than five times per year, with no application within the last six months. Excessive opening of new accounts in a short time also affects the length of credit history negatively.
As payment history and usage rate are the most significant portion of a score, which accounts for 65%, paying all the bills on time and maintaining balances below 30% will be most effective. Not making errors such as missed payments, maxing out credit limits, etc. does exactly as much to help as boosting scores in the fair to good range. Besides the adoption of responsible credit habits, another way of raising scores is by periodically checking the credit reports and correcting the mistakes at an early stage.
As credit scores play a significant role in the lending process, it is crucial to comprehend these factors. Therefore, measuring the five main parameters highlighted above and ensuring that credit best practices are followed will assist in the building and enhancement of scores. This group of people with excellent credit scores ranging from 750 to 850 points has a favorable position when it comes to the rates and terms of credit products. Hence, keep an eye on your credit utilization, avoid credit checks, and ensure you do not miss payments to watch your credit score rise.
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