What is a credit score and why it matters
What's the story
Credit score, also referred to as CIBIL score in India, is an integral part of determining an individual's financial health.
These scores, which range between 300 and 900, are utilized by lenders to gauge the risk involved in lending money or extending credit to an individual.
A higher score means lower risk, resulting in better loan terms.
Here's how credit scores work and the factors affecting them to help you maintain long-term financial stability.
Key elements
Factors influencing credit scores
Several factors contribute to your credit score. Notably, payment history accounts for 35%, making it the most important factor.
The amount owed makes up 30%, while the length of credit history contributes 15%. New credit and types of credit used each account for 10%.
Knowing these elements helps in managing your finances effectively.
Payment impact
Importance of timely payments
Timely payments are crucial as they constitute a major portion of your credit score calculation.
Late payments can adversely affect your score, making it difficult for you to get loans or good interest rates in the future.
Setting up reminders or automatic payments can help you ensure that the bills get paid on time, thereby keeping your credit profile healthy.
Utilization strategy
Managing credit utilization ratio
The credit utilization ratio is another important factor influencing your score.
It is determined by dividing total outstanding debt by total available limits and expressed in percentage.
Keeping this ratio under 30% is recommended for maximum scoring benefits.
Keeping an eye on this ratio from time to time can save you from adverse effects on your overall financial health.
History significance
Building a long credit history
A longer credit history usually translates into a better score since it gives more data points for lenders to assess risk accurately.
Keeping older accounts open and active contributes positively to this aspect of scoring.
Even if you don't use certain accounts frequently, maintaining them can be beneficial over time.
Account variety
Diversifying types of credit accounts
Having various kinds of accounts, like installment loans and revolving credits, can give a boost to your score by indicating lenders that you can handle different types of debt responsibly.
However, opening too many new accounts simultaneously may hurt you at first (hard inquiries on your report), but diversifying over time helps you build strong financial credibility.