Do You Know How Your Credit Score Works?
Many of you must have heard the word ‘credit score’ or ‘CIBIL score’. It is mentioned frequently when you apply for a loan. But do you know what it means?
Your credit score or CIBIL score is actually an indication of your credit worthiness. When banks and financial institutions consider lending you funds, they want to make sure that you are capable of repaying the loan along with the applicable interest. Your credit score determines your capability to repay the loan. Since this score determines whether you would be able to get a loan or not, let us understand the meaning of the credit score and factors influencing it.
What is Credit Score?
A credit score is a three-digit number ranging from 300 to 900 based on your credit history. The credit report company collects your credit related transaction records. It uses the information to create your Credit Information Report and assign you a credit score. This score is available to banks and financial institutions and they use it to determine your eligibility.
A credit score above 750 is usually considered good. Lenders allow loans to individuals having scores higher than 750. In fact, the closer you are to 900, the better the chances of you availing a loan easily. Low scores are considered bad and you might face problems availing a loan if your credit score is below 750.
Factors Constituting and Influencing Your Credit Score
Your credit score is calculated after careful calculations based on a number of factors. These factors form a part of your credit score and also influence it. Let’s see what these factors are:
- Repayment History
Your credit score comes into the picture as soon as you avail any credit (loans or credit cards). The repayment history takes into account all the repayments you did for any credit you availed. Repayment history constitutes the major chunk of your credit score accounting for 30% of your score. If you have never defaulted on your earlier loans or credit card bill payments, your repayment history would be favourable and help in increasing your overall credit score.
- Credit Mix
The next constituent of your credit score is the type of loans or credits availed by you in the past. The credit mix measures the ratio of secured loans to unsecured loans in your credit portfolio. It also takes into account the length of your credit history, i.e. for how long have you availed of existing loans. Secured loans are better as they reflect that you have a sound financial footing. Home loans, auto loans, education loans, loans against properties are types of secured loans which have a favourable impact on your credit score. On the other hand, Personal Loans and credit cards are unsecured loans. In fact, you can avail Personal Loans with CIBIL check too. However, higher the unsecured loans you have the lower would be your credit score. Credit Mix constitutes for 25% of your credit score.
- Credit Exposure
The next factor is the amount of credit which you have availed. A higher credit availed by you within a short period of time is bad. It depicts that you might be living beyond your income level which denotes bad credit worthiness. Credit exposure dominates 25% of your credit score.
- Other Miscellaneous Factors
The last 20% of your credit score is composed of various smaller factors like credit utilization, for how long have you been availing credit and your current credit paying behavior.
So, the working of your credit score can be depicted through the following pie-chart:
This is how your credit score works. There are some points which you should remember with reference to your credit score. These points are as follows:
- Your credit score is dynamic. It changes with changes in your credit history.
- If you have a low score, you can improve your CIBIL score by taking corrective measures like cutting down on credit instruments, making repayments on time, having secured loans, etc.
- Before applying for a loan, you should check your credit score.
- Multiple inquiries into your credit score have a bad impact on your score. So, when applying for a loan, do not make multiple applications.