Have you ever considered taking out a low-interest home loan to build your dream home? Or have you wanted to apply for a premier credit card that would give you incredible benefits? Or do you want to rent an apartment in an exclusive neighbourhood? In all three scenarios, one factor will affect your ability to realise your desires: your credit score.
Just as your test scores in school and competitive exams impact your future scope, your credit score, too, influences your financial present and future.
Understanding credit scores will lay a strong foundation towards achieving financial literacy and freedom. To secure your financial future, read on.
What is a Credit Score?
A credit score is a numerical representation of your creditworthiness. This three-digit metric, ranging between 300 and 900, encapsulates an individual’s credit history by measuring their capacity to repay credit. A high credit score implies that you use your credit responsibly and indicates good financial health. A lender forms their first impression of you based on your credit score, and as we all know, the first impression can be a lasting one.
While there are different credit score ranges and scoring models, your creditworthiness can generally be categorised as follows:
- NA/NH: When an individual or business has no credit card or loan against their name, it implies they have no credit history.
- 300-500: A credit score in this range makes the individual unattractive to potential creditors and lenders due to their high risk.
- 501-650: A credit score in this range indicates a high risk of extending credit. A history of high credit utilisation, unsecured loans, and missed or delayed payments are reasons for the low score.
- 651-750: With a score in this range, an individual is considered a low-risk borrower with an average or fair credit history.
- 751-850: A score above 750 is considered a good credit score indicating a good credit history with little risk for the creditor.
- 851-900: With a credit score in this range, an individual falls within the lowest risk category for creditors. Easy approval and beneficial terms are guaranteed for individuals in this category.
What Affects Your Credit Score?
Generally, a credit bureau will collate the following data to determine your creditworthiness:
Payment History
Agencies check whether you have made on-time payments, how many times you have made delayed payments, how many days past the due date payments are made, etc.
Credit Utilisation
Credit bureaus check the amount you owe to your creditor. Low credit utilisation (about 30% for credit cards) is good for the credit score.
Length of Credit History-
The longer your credit history with on-time payments, the higher your credit score. Having a long credit history strengthens this part of your score.
Credit Mix
A good mix of credit products, like credit cards, home loans, and EMIs, strengthens this section of your credit score.
New Credit
Opening new lines of credit and recent credit activity contributes to your credit score, too.
Ways to Improve Your Credit Score
Your credit score is not a static metric. You can always work to improve your credit score to access the benefits that come with high creditworthiness. Think of it as a process of continuous evaluation.
Here’s what you can do to improve your credit score:
Make On-time Payments
You mustn’t dilly-dally on your credit payments. Pay back your dues on time and show that you are fiscally responsible and can pay your dues.
Review Your Credit Reports
Knowing what is working for and against you will help you build a plan of action. This is where you can study your credit reports to identify areas that you can work on to improve your credit score. You can also raise disputes if there are errors in your report.
Optimise Credit Utilisation
High reliance on credit is a red flag for lenders. An important rule of thumb is not to utilise more than 30% of your credit limit. Paying your dues in full every month and setting an alert once you have reached the upper limit of your credit usage can help you achieve this.
Keep Your Old Accounts Open
Old is gold, and old accounts are just as vital to boost your credit score. The length of your positive payment history is a green flag to lenders. Additionally, keeping old accounts open allows you to keep your credit utilisation ratio low.
Limit Requests for New Credit
Hard inquiries from banks while applying for new credit can impact your credit score negatively in the medium term. Too many hard inquiries in a short span indicate that your requirement for credit has increased, so you are a risk.
Diversify Your Credit Mix
A good mix of credit can boost your credit score. But be mindful that you are not taking on too much debt in the process.
Conclusion
Your credit score is an indicator of your financial health. It can either raise a red or green flag to the lender. In either case, the many perks of having a high credit score incentivise taking a careful look at your credit score and report and making a conscious effort to improve your credit score. After all, being responsible with your finances motivates lenders to extend credit on extremely favourable terms.
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