How is a Credit Score Calculated and What Factors Influence It?
Each credit bureau has a number of standard scoring models and some may even offer customized models. While the specifics of each model are kept secret, there are several key factors that influence a person's credit score. Understanding these factors can greatly help in improving one's credit score. This article delves into the main components that affect a credit score and offers practical advice on how to enhance it.
Repayment History: The Most Significant Factor (30%)
One of the most influential factors in a credit score is the repayment history, which comprises about 30% of the score. Lenders consider this factor heavily as it reflects a person's ability to make timely payments. To improve this aspect, make sure to consistently repay credit card bills and loan EMIs on time. Ensuring timely payments can significantly contribute to building a strong credit score, which is essential when applying for loans or other financial services.
Credit Utilization Ratio: A Key Component (25%)
The credit utilization ratio is another critical factor, contributing to 25% of a person's credit score. This ratio indicates the percentage of one's credit limit that is currently being used. A high credit utilization ratio may suggest a high or excessive reliance on credit, which can lead to a lower credit score. On the other hand, a low credit utilization ratio can result in a higher credit score. It is advisable to keep the credit utilization ratio below 30% to maintain a favorable credit score.
Credit Mix and Age of Credit History (25%)
The credit mix and the age of one's credit history are additional factors that account for 25% of a credit score. Individuals with a mix of secured and unsecured loans typically have a stronger credit score than those with only one type of loan. Additionally, the length of a person's credit history is also important. A longer credit history often correlates with a better credit score. It is recommended to avoid closing old loan accounts and credit cards as they can provide a positive impact on the credit score.
Hard Enquiries: Impact on Credit Score
Hard inquiries refer to the times when a credit bureau checks a person’s credit history, usually when applying for a loan or credit card. Each hard inquiry can slightly lower a person's credit score as it is seen as an indicator of excessive reliance on credit. To minimize the impact of hard inquiries, it is best to consolidate loan applications and avoid frequent inquiries within a short period. This practice can help maintain a good credit score and attract better loan terms in the future.
While there is no standard formula to calculate a credit score, keeping these factors in mind can greatly help in improving one's credit score. By understanding and addressing these components, individuals can work towards building a strong credit profile that is beneficial for financial health and future loan applications.