Raj thought he had it made! He was from a poor family and had studied very hard, he had got a scholarship to go to a college he could not afford on his own, and eventually, landed a job in the one of the biggest multinational firms. Now life was going on smoothly, with a large family, he planned to buy a new home. He went to his nearest bank where he had his salary account, and asked for a loan. An hour later and a few phone calls later, he came out disappointed and determined to work more on his credit score.
What is a Credit Score?
A credit score is like your borrowing karma, it, along with multiple other factors helps determine your eligibility to get a loan. It is a number that reflects how much of a risk a financial institution considers you to be. Simply put, higher the credit score, higher the chance of you getting the loan you want.
It not only determines WHETHER you get the loan, but also decides, how much you can borrow and the rate of interest that will be charged to you. Now, that is a pretty big deal!
So it is essential to understand what makes up the credit score. Your credit score will be based partly on your credit history, which is a record of how much you’ve borrowed in the past and today and how well – or badly – you’ve managed your debts. Let us look at it more in detail.
What Goes into a Credit Score?
Payment History: Your parents always used to say, Pay your bills on time, and it is true in today’s world more importantly than ever. A credit card bill late/no payment can haunt you forever. Instant gratification will have long term repercussions. It like they say for weight loss, one moment on the lips forever on the hips. Negative items generally remain on credit reports for 7 years but bankruptcies or other public records can stay on for longer.
But wait a minute, you have never borrowed money! How are you expected to show a good payment history? It is a very catch 22 situation:
No loans? No credit history.
No credit history? No loans.
But relax, it doesn’t mean you can’t buy that dream house. It just means your options will be limited. And this will pave the way for future loans.
Debt Level: I think you may have understood by now that borrowing more means better credit history. Yes and No. There is good credit and bad credit. But generally, having borrowed more, may mean good score provided, you have paid it back regularly and have not borrowed disproportionately to your income, making repayments unaffordable.
Length Of Credit History: the longer and smoother the credit history, the better the score. It takes several years to build a good score, and sometimes over 10 years to build an excellent one.
Inquiries: Inquiries for your credit rating may impact your credit score. There are two types of inquiries on a credit score: One which is made by a financial institution with your permission, while making Yes or No decisions on your loan requirement; and the other is made by you to keep a tab or an employer for your background check. The former impacts your credit score negatively, the latter may not.
Mix of Credit: Mix of credit shows to the lenders your ability to handle various types of loans. This is not the most important factor in determining the terms of your loans, but it is helpful as it helps the lender understand your experience in the borrowing game.
But that doesn’t mean that a user apply for all kinds of loans for variety, as the the number of hard enquiries will impact your credit score. There is also a chance that you may not be able to handle all that responsibility.
Here is something to help you understand the components of your credit score:
Components of Credit Score
Suggestions for Good Credit History and Score
So now that we have understood that credit score is very important to maintain a good credit score. Here is a refresher of the skills you need to maintain a good credit history:
- Pay your bills on time. Try putting reminders in your calendars or bank account. Or allow automatic payment of credit card debt. Delayed payments by even 1-2 days can have a negative impact on your score. If you have any missed payments, pay them now! The more delayed the payments, the worse the impact. The impact of past history fades if you are managing your credit well in more recent times.
- Keep your credit card balances low. Higher outstanding debt will affect your credit score
- Manage your debt. If you have been having a very short credit history, don’t open a multitude of accounts now. Rapid opening of accounts looks risky, and reduces your average account age. Take debt that you can manage financially, if repayments are making your life difficult, meet a consultant.
- Don’t close old credit cards. Closing old credit cards is a short term strategy used by many to improve credit score, but it is not the right strategy, as it takes away a good length of your credit history.
- Limit your applications for new credit. Apart from increasing the number of inquiries, multiple applications raise a red flag in the minds of lenders, be careful not to go overboard.
- Watch your credit report. Now you watch your account balances, and your returns on investments carefully. This credit report deserves same, if not more, importance. Check your credit report regularly, this is not only good financial sense and helps you understand results of your actions, but it also ensures you don’t apply for a loan that will get rejected.
If you are on the market for loans, you took a big step today by understanding the components which go into making of your credit score. Take the above steps to help improve your credit score, analyze your finances, and take the right step for your needs with our help.