Credit score plays a crucial role in determining your loan eligibility, interest rate and occasionally even your employment. Ever wondered why banks and other financial entities give so much importance to this three-digit numerical expression.
It must be puzzling for many as to how the number is derived and what goes into the calculation of your credit score. If you still have not yet figured it out, this article is an eye-opener.
What Is a Credit Score?
A credit score is a three-digit number which represents an individual’s credit history. It is a snapshot of your credit worthiness. The range of your credit score can vary anywhere between 300-900.
Additional Reading: Why Your Credit Score Is Important to your Financial Future
How the Credit Score Is Calculated?
There are 4 credit bureaus that issue your credit score and report in India when asked for. Banks report your credit related activities to credit bureaus every month, based on which your credit score is calculated. You may not get the same credit score from all the credit bureaus as the timeline varies for each of them.
There are lot of components involved in computing this mysterious credit score. Let us look in detail the weightage limit for various factors.
1. How Good Is Your Past Record?
Your payment history holds a considerable weightage on your credit score. This is the proof to your lender about your financial discipline and creditworthiness. Defaults and delinquency can have an adverse impact on your credit score. About 30% of weightage is given to your payment history.
2. How Old Is Your Credit Record?
Older your credit history, higher your credit score! The length of your credit history is an important factor to evaluate your credit score. It shows to the lender how long you have been in the credit system. About 25% of weightage is given to your credit length.
The type of credit you have taken whether secured or unsecured loan is also included in this calculation.
3. Credit Exposure:
This will get 25% of weightage on your credit score. This is the total amount of credit extended to you by various lender.
4. Other Factors:
The rest 20% of weightage is given to other factors like credit utilization and recent credit behaviour.
Importance of your credit score in the loan-approval process
A credit score of 750 and above is a good score to have as it indicates that you have a good track record of fulfilling your loan obligations. A low credit score signifies that you do not have a good history of making repayments and have a higher probability of default.
Potential lenders first look at a customer’s credit score to evaluate whether to process the application further. Data shows that an overwhelming majority of all loans that are sanctioned are made to customers with a credit score of 750 or above. Other advantages of a high credit score include:
• Lower interest rate
• Bigger loan amount
• Longer tenure
• Quicker approval process/simpler documentation
• Higher card limit
Additional Reading: 5 Important Tips to Improve Your Credit Health
Your credit score does have an impact on your loan application and determines whether you are qualified for a loan or not. Having known the importance of Credit Score, you can now take all the necessary steps to improve your score.
If you want to check your credit score for free, Click here.