Credit Score Calculation: The Biggest Secret Revealed

A lot has been said about the importance of having a strong credit history and a high credit score. A high credit score is your gateway to quicker home, personal loans and car loans, lower interest rate credit cards, approval for higher credit limits, and so on. There are several ways to maintain and improve your credit score. However, do you know how a credit score is calculated, and what are the factors that affect your credit score? What are the factors the credit bureaus such as CIBIL, Experian, and Equifax, take into consideration while calculating your credit score? Let’s take a detailed look at all these aspects.

What is a Credit Score?

A CIBIL score is a numerical representation of an individual’s creditworthiness. It is a number between 300-900, 900 being the highest, that shows how financially responsible you are when it comes to taking care of your debt. A credit score of 750 and above is considered ideal by major banks and non-banking finance companies (NBFC). The credit bureaus in India which are regulated by the Reserve Bank of India (RBI) offer credit scores that are calculated on the basis of an individual’s credit history and repayment behavior. You can also check your credit score for free on several websites like BankBazaar.com.

What are the Factors Affecting Credit Score?

  • Repayment History: The repayment history accounts for 35% of your total credit score. It is one of the key factors that decide your credit score. It is extremely important to have a consistent payment record. You should never default on your bill payments as it will have a negative effect on your credit score. If you do not have a good repayment history, banks and NBFCs will consider you incapable of handling credit.
  • Amount of Debt: Along with your repayment history, the amount of debt you owe accounts for 30% of the total credit score. Therefore, it is important that you should always be aware of your current status of wealth and take only that amount of credit that you can repay without any struggle. One of the keys to keeping a tab on your credit is to maintain a low credit utilization ratio. You should ideally use 30% or less of your credit limit and make sure to minimize your debt. A higher utilization ratio suggests you are credit hungry and can hamper your credit score.
  • Age of Credit History: The length of your credit history accounts for 15% of your total credit score. The age of credit history is the number of years that have passed since you have opened your first credit account. It also considers the time since the last account activity. It is better to have a decent credit age as it shows that you have a lot of experience in handling credit.
  • Type of Debt: There are two types of debts – secured and unsecured. It will boost your credit score if you have a healthy mix of both the type of debts. This essentially means it is good to have a car or home loan as well as a credit card. The type of debt accounts for 10% of your total credit score. The credit bureau also considers the number and proportion of the recently opened accounts by the account type.
  • Credit inquiries: Credit inquiries account for 10% of your total credit score. The number of applications an individual makes to avail credit has an effect on your credit score. All the inquiries made about loans or credit cards gets placed recorded in your credit report.

How to Improve Your Credit Score?

  • Check and monitor your CIBIL score and report: It is important to check your credit score regularly, as it gives you an idea about your financial health. The Reserve Bank of India (RBI) has made it mandatory for all the credit bureaus in the country to offer one free credit report to individuals in one calendar year. Another reason to check your credit score is to see whether there are any errors or false records about your credit account. There can also be a possibility of identity theft. If you spot any errors in your credit report, you can raise a dispute with the bureau and get it resolved.
  • Make bill payments on time: Always make it a point to pay your bills on time as it is one of the biggest factors that affect your credit score. Make sure to pay your credit card bills and home loan EMIs on time. If you think it is difficult to keep a track of your credit card payments, you can give standing instructions to your bank to pay off your credit card bill automatically before the due date.
  • Avoid hard credit checks: Don’t apply for a loan or a credit card application immediately, if it gets rejected in the first attempt. A credit application or request attracts a hard credit report check by financial institutions and banks. Every time a hard credit check is carried out, it can negatively impact your credit score.
  • Get a credit card if you don’t have one: It is not necessary for you to have multiple credit cards, but you can have one or two credit cards, having a credit card helps in building a credit history and thereby builds your credit score. If you are new to using a credit card, make sure to use it only when you know that you are in a position to repay it without any hassle.
  • Don’t remove old accounts: It is advisable to remove or deactivate old accounts or accounts with a negative history. Also, removing old debts from the report after paying them off affects your CIBIL score negatively. Getting old accounts removed may harm your CIBIL score a lot as they may have good records of repayment history. In order to maintain a good CIBIL score, it is better to keep all the records of paid debts.
  • Always make full payments: Get into the habit of paying the entire bill amount and never pay the minimum amount due on your bills. This suggests that you are struggling to repay your credit debts. Also, if you keep paying the minimum amount due on your bills, you might end up paying a huge amount in interest fees.
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