A credit score is a statistical number that assesses an investor or consumer’s creditworthiness. It is based on the individual’s credit history. Today, lenders focus on credit scores to evaluate the probability of an individual repaying his or her debt obligations. A person's credit score could range from 300 to 900, and the higher the score, the more financially able a person is considered to be.

What is Credit and Credit Score

Understanding Credit - Credit is the ability to borrow money or access goods or services with the understanding that the borrower will pay later. Creditors (including Lenders, merchants and service provider) grant credit to individuals or companies based on their confidence that the borrower can be trusted to pay back what they have borrowed, along with any finance charges that may apply.

Understanding Credit Scores - These help lenders in determining whether or not a loan application can be approved and determining what loan terms need to be offered to a borrower. The score is generated by an algorithm using information from the individual’s credit reports, which summarize his or her borrowing history.

Types of Credit

There are three main categories of credit generally available for borrowers:

Revolving Credit

This is one of the most common types of credits. It is a line of credit that has no cap on borrowing or how much can be used at any given time. It includes credit cards and home equity lines of credit and it generally requires monthly payments and interest charges if borrower carries a balance. 

Under revolving credit, the credit limit does not change when the borrower makes payments on the revolving credit account. A borrower can return to the account to borrow more money as often as he or she wants, as long as the maximum limit is not exceeded.

Instalment Credit

The most unique features of an instalment credit account are the predetermined length and end date, often referred to as the term of the loan. The loan agreement includes an amortization schedule, in which the principal is gradually reduced via instalment payments over the course of several years.

This type of credit refers to a loan for a set amount of money with a fixed, regularly occurring repayment schedule. It includes a wide variety of loans such as student loans, mortgages, auto loans, personal loans, etc. 

Open Credit

Open credit is uncommon and not many people tend to opt for this form of credit. It refers to accounts that one can borrow from which have a fixed limit (similar to a credit card). The borrowed amount must be paid back in full each month. Open credit is generally linked to charge cards.

Importance of Having Different Types of Credit to Improve Credit Score

Diversity of credit accounts is one of the most common factors used to calculate credit scores. However, it is generally overlooked by most consumers. Maintaining different types of credit accounts, such as a mortgage, personal loan and credit card, indicates to lenders that one can manage different types of debt at the same time. It also helps them get a clearer image of the borrower’s finances and ability to pay back the debt.

While having a less diverse credit portfolio won't necessarily result in lowering of scores, the more types of credit one has the better it is considered as long as all repayments are made on time. Credit mix accounts for nearly 10% of credit scores and could be an influential factor in helping to achieve a top score.

Factors Impacting Credit Score

Some of the important factors that can negatively impact the credit score are:

  1. Missing repayments: Payment history is one of the most important aspects that affect the credit score. This means even a single 30-day late payment or missed payment can have a negative impact.

  2. Using all available credit: High credit utilization can indicate trouble to creditors and means that the borrower is too dependent on credit. Credit utilization is calculated by dividing the total amount of revolving credit that a borrower is currently using by the total of all the available credit limits. Lenders like to see credit utilization under 30% and if it’s under 10% that is considered even better. 

  3. Too much credit in too little time: Each time a lender requests a borrower’s credit reports for a lending decision, a hard inquiry is recorded in his or her credit file. These inquiries stay in the file for two years and can result in a credit score to go down slightly for a period of time. Lenders look at the number of hard inquiries to gauge how much new credit the borrower is requesting. Too many inquiries in a short period of time can signal that the borrower is in a bad financial situation or is being denied new credit.

  4. Defaulting on accounts: The types of negative account information that can show up on the borrower’s credit report include foreclosure, bankruptcy, repossession, charge-offs, settled accounts. Each of these can severely hurt the credit for many years.

Ways of Improving Credit Score

While trying to assess ways of improving credit score, it is important to focus on the reasons why the credit score could possibly be struggling. This allows a borrower to develop better credit habits and can have a positive impact on the credit score in the long run.

Here are some of the ways in which a borrower can improve credit score:

  1. Timely Bill Payments: Payment history is the most important factor in making up a borrower’s credit score and hence making all the due bill payments on time every month is critical to improving credit score.

  2. Debt Repayment: Reducing credit card balances is a great way to lower credit utilization ratio, and can be one of the quickest ways to see a credit score boost.

  3. Completing Outstanding Payments: If a borrower has any payments that are past due, bringing them up to date may save his or her credit score from taking an even bigger hit. Late payment information in credit files includes how late the payment was—30, 60 or 90 days past due—and the more time that has elapsed, the larger the impact on credit scores.

  4. Disputing Inaccurate Reports: There is always a possibility that a credit score report could contain inaccurate information about the borrower and this can be disputed by conducting appropriate research and submitting good evidence. This requires constant monitoring of credit scores and related information. The faster a dispute is raised, the higher the chances of it getting corrected.

  5. Ensure Having Credit Score: For borrowers who wish to get a genuine credit score, the best alternative is to seek a credit score from an established and trusted source online. CreditMantri is one helpful source that can provide accurate and detailed credit score report which can be used to establish a good credit history.

End Note

A healthy credit mix can significantly help in improving credit score.  Having a good credit mix, paying off loan obligations on time, applying for credit accounts only when needed, are some of the aspects to look after while applying for a new credit. Read here to find out how you can have a good credit score. Also, check your credit score today at CreditMantri to ensure that you can avail any type of credit when required.