What is a credit score, and why is it important? 

From education and employment to shopping and dining, ranks and ratings have become an essential part of our world. Their significance is even greater in the financial world. One such crucial financial rating is a credit score. This article explains a credit score and how a good credit report impacts your financial life.

What is a credit score?  

A credit score is a three-digit number that represents your creditworthiness. It essentially estimates your ability to repay loans on time and your consistency as a borrower. This evaluation is based on several factors, such as payment behaviour, outstanding debt and the length of credit history. 

Lenders report your credit profile and behaviour to credit bureaus, which compile it into a Credit Information Report, commonly known as a credit report, that reflects your credit score. Credit scores range from 300 to 900, with scores above 750 generally considered good.

In India, the Reserve Bank of India has licenced four credit bureaus: 

1. TransUnion Credit Information Bureau (India) Limited or TransUnion CIBIL 
2. CRIF High Mark 
3. Experian 
4. Equifax

Factors that affect your credit score 

Wondering how a credit score is calculated? It takes multiple factors into account. Here are the key ones: 

1. Payment history 

Borrowing is a common practice. However, what truly matters is how efficiently you repay your debts. Your payment history is a critical indicator of your creditworthiness. Consistently making payments on time boosts your credit score. On the other hand, missed or late payments and defaults negatively impact it. 

2. Credit Utilisation Ratio (CUR)

You might be making timely repayments, but the extent to which you use the available credit also matters. CUR is the percentage of your total credit limit that you have used. Ideally, you must keep your CUR below 30%. For instance, if your credit card limit is ₹1 lakh, you must try to limit your usage to ₹30,000 to contribute to a healthy score. 

3. Length of credit history

A longer credit history usually contributes to a higher score. This is because of several reasons. It reassures lenders that you can manage credit over time and are less likely to default on payments. It also gives you an opportunity to establish a strong payment record. Older accounts with positive track records enhance your score, as they indicate responsible credit behaviour. 

4. Credit mix

Having a diverse mix of credit, including credit cards, secured loans, and unsecured loans, also works in your favour. It demonstrates your ability to manage different types of credit efficiently. However, merely having a good mix is not enough. You must ensure timely repayments across all credit types for a positive score. 

5. New credit 

Applying for new credit frequently can weaken your ability to manage existing debts more efficiently. Each time you apply for credit, lenders conduct a hard inquiry, which temporarily lowers your score. 

Importance of a good credit score 

Here are some reasons why maintaining a good credit score is essential: 

1. Faster credit approvals: A credit score helps you get quicker loan approvals because it reassures the lender of your creditworthiness. This is especially beneficial during emergencies.
2. Lower interest rates: A higher interest rate on loans means increased borrowing costs and greater repayment stress. A good credit score can qualify you for lower interest rates, resulting in significant savings over time. 
3. More negotiating power: With a good score, you can negotiate for better loan terms, such as lower processing fees, higher loan amounts, and more flexible repayment options. 
4. Lower insurance premium: In some cases, insurers consider credit scores when determining your premium amount, particularly for auto insurance. A good score can help you secure lower monthly premiums.  
5. Better employment opportunities: Some employers, especially in the financial sector and for high-paying roles, review credit scores as part of the hiring process. A poor score can limit your job prospects. 
6. Easier rental approvals: Landlords may also check credit scores before renting out their property to assess and avoid the risk of late payments or defaults. A strong score increases your chances of renting a place of your choice.

Tips for improving your credit score

Here are some effective ways to enhance your credit score:  

1. Make timely payments

Since your repayment history majorly impacts your credit score, making timely payments can drastically improve your credit score. Automate your payments, opt for reminder notifications, and plan your finances well to avoid missing due dates. 

2. Lower your credit utilisation 

Keep track of your credit swipes and avoid relying on it for regular expenses. Use it primarily for emergencies to maintain better control over spending. You can also consider increasing your credit limit while still maintaining the same spending level. This will help lower your CUR. 

3. Avoid taking multiple loans in a short period

Space out your loan applications to avoid appearing as a high-risk borrower. Consider diversifying your credit mix and planning your repayments strategically, as this may actually enhance your score. 

4. Be cautious about being a guarantor

Your credit score is impacted by others’ credit behaviour, too. If you become a guarantor for someone’s loan, a default on their part could negatively impact your financial profile.  

5. Regularly check your credit report  

Errors or fraudulent activities can lower your credit score without your knowledge. Regularly review your credit file and report discrepancies immediately to avoid or reverse their negative impact on your score. 

Thinking about how to check your credit score? Simply visit the official website of the credit bureau and fill out a form with your personal details, such as your full name, email address, and date of birth.  

Conclusion 

Your credit score reflects your creditworthiness. Maintaining a good score is essential for a healthy and secure financial life.