How Credit Scores Are Calculated?

 A good credit score is critical as it can impact many areas of your financial life, from obtaining a loan to securing a lease or even employment. But, how do credit scores get calculated? Further, we will break down the factors that determine your credit score and how they get weighed so that you can better understand this essential number.


 Payment History 

The payment history is the most crucial element that determines your credit score. It carries the maximum weightage of 35% in the commonly used credit scoring model. Your payment history reflects whether you have been making timely and complete payments.  

Failing to do so, i.e., missing or delaying payments, can adversely impact your credit score. Therefore, it is crucial to make timely payments, even if it's just the minimum amount. 

Credit Utilization 

Your credit utilization is the second most crucial element that determines your credit score, accounting for 30% of the total score. Credit utilization reflects the proportion of credit that you are using compared to the total credit available to you.  

Lower credit utilization is beneficial for your credit score. It is recommended to keep your credit utilization below 30% to maintain a good credit score. 

Length of Credit History

The length of your credit history is a significant contributor to your credit score, accounting for 15% of the total score. It reflects the duration of your credit accounts, i.e., how long you have had them open. A more extended credit history is favorable for your credit score. 

Therefore, it is crucial to start building your credit early and keep your credit accounts open, even if you use them infrequently.

Types of Credit 

The different types of credit accounts you have can also impact your credit score, which accounts for 10% of your total score. Having a mix of credit accounts, like credit cards, car loans, and mortgages, can improve your credit score. So, it's a good idea to have different types of credit accounts to build a strong credit profile.

New Credit

The opening of new credit accounts and credit inquiries are factors that can affect your credit score, contributing to 10% of the total score. Whenever you apply for new credit, such as a loan or a credit card, it results in a credit inquiry.  

Having too many credit inquiries can harm your credit score. Therefore, it is important to limit the number of credit inquiries and only apply for credit when it is necessary.

Secured Credit Cards

If you're just starting to build your credit history, a secured credit card can be an excellent option to consider. Unlike traditional credit cards, secured credit cards require you to put down a deposit as collateral, making it less risky for the lender.  

This type of credit card can help you establish a credit history, especially if you don't have a credit history, or if you have a poor credit score.

Cashback and Discount Credit Cards

Credit cards that offer cashback or discounts on purchases can be an excellent way to save money while also building your credit history. These types of credit cards often require you to have a good credit score to qualify, but if you do, they can be a great way to earn rewards while also improving your credit score.

Conclusion 

Your credit score is an essential number that can impact many areas of your financial life. Understanding how your credit score is calculated can help you to make smarter financial decisions and take steps to improve your credit score over time.  Remember to always make your payments on time, keep your credit utilization low, and maintain a mix of credit accounts for the best possible credit score.

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