What is credit score?
A credit score is a number that reflects your creditworthiness or how likely you are to repay borrowed money on time. It's based on your credit history, which includes information like your payment history, the types of credit accounts you have, and how much debt you owe.
How does Credit score work?
Your credit score acts like a report card for your borrowing habits, telling lenders how responsible you are with managing debt. Here's a deeper look at how it functions:
1. Information Gathering:
Credit Bureaus: Four major credit bureaus ( TransUnion CIBIL, Experian, Equifax, and CRIF High Mark.) collect information about your credit activities from lenders, creditors, and other entities. This information is compiled into your credit report.
Credit Report: This report includes details like your payment history on loans and credit cards, credit utilization (how much you owe compared to your credit limit), types of credit accounts you have, and the length of your credit history.
2. Scoring Models:
Credit Scoring Companies: Companies like FICO and VantageScore use complex algorithms to analyze the information in your credit report and generate your credit score.
Factors Considered: These algorithms weigh various factors from your credit report, with the most significant being:
Payment History: This has the biggest impact, with on-time payments positively affecting your score and missed payments hurting it significantly.
Credit Utilization: Keeping your credit card balances low compared to your limit shows responsible credit usage and improves your score.
Length of Credit History: A longer credit history with accounts managed responsibly generally strengthens your score.
Credit Mix: Having a diverse mix of credit accounts, such as credit cards and installment loans, can positively impact your score.
New Credit: Applying for too much new credit in a short period can negatively affect your score.
3. Score Interpretation:
Score Range: Credit scores typically range from 300 to 850, with higher scores considered better.
Score Meaning: A higher score indicates a lower risk of defaulting on loans and makes you more likely to qualify for credit at favorable terms, like lower interest rates. A lower score suggests a higher risk, making it challenging to get approved for credit or resulting in less favorable terms.
4. Utilizing Your Score:
Lenders and Creditors: They use your credit score to assess your creditworthiness before approving you for loans, credit cards, or other forms of credit.
Other Applications: Landlords, insurance companies, and even some employers might use your credit score in their decision-making processes.