How Length of Credit History Affects Your Credit Score
Your credit score plays an important role in determining your creditworthiness. Lenders access your credit score before your loan application is processed for approval. Based on your credit score, the approval and interest rate are determined. A credit score is generated only when an individual becomes a borrower with banks or NBFCs.
Did it ever strike your mind that the length of your credit history can affect your credit score? Well, it does! The longer your credit history, the better will be your credit score. Let us now look in detail how the length of your credit history plays a role in your credit score calculation.
Understanding Credit Score Calculation
Your credit score is generated soon after you have availed a loan or credit card from lenders. It could take up to 6 months for your credit score to be generated after you have taken your first loan or used your first credit card.
Generally, it is difficult to evaluate a person unless you have known the individual for a longer period of time. The same applies to creditworthiness. Banks can assess a person’s creditworthiness based on how long the borrowers is associated with them. Hence, your credit history too plays a role in your credit score and thus a specific weightage is given to it.
Credit bureaus calculate your credit score using certain factors. The score generally ranges between 300 to 900. Though all the bureaus have similar criteria to calculate the credit score, the weightage on each parameter could differ based on their internal policies.
Following are the parameters that play a crucial role in credit score calculation:
Payment History: It has a major weightage on your credit score as it tells your payment activities after taking the credit. A positive payment history will lead to a good credit score and a negative history with defaults and delinquencies will hurt your credit score.
Credit Utilisation Ratio: It refers to the amount you have used against the available credit limit. A low credit utilisation ratio (ideally below 30-40%) gets you a positive credit score. It is generally applicable for people who have credit cards.
Length of Credit History: If you have a longer relationship with the bank in terms of borrowing activities and you have a positive track record of repayment, the lenders find you a reliable borrower. Hence, the age of credit history becomes one of the important criteria for assessment.
Credit Mix: Having experience with different types of credit such as credit cards, secured loans and unsecured loans, shows the lenders that you can handle multiple credit efficiently. This is one of the parameters for assessment and a good credit mix will help you improve your credit score.
Age of Credit History and Credit Score
As we have now known that the length of your credit history is one of the criteria in credit score calculation, let us look in detail how it affects the credit score.
The reason why lenders look at the average length of credit history of their borrowers is because if a borrower has paid regularly over a long period of time, that would mean that that borrower if worth risking their money for. Through their credit history, the lenders would be able to speculate if the borrowers would be able to repay their money on time consistently or not.
Hence, it’s always advisable to pay money regularly on your credit. Now, if you have a credit card that you have been using for quite some time and paying your bills on it regularly, it is suggested that you don’t close that card. You might be seeing a plenty of new credit cards with exclusive offers that would be very beneficial for you, so you might think of closing your old credit card to get that new one.
But before you do so, you must consider that it would reduce your average age of credit history, which would have a negative impact on your credit score. So, if you close your old credit card accounts to open new ones or you open multiple new accounts within a short period of time, your average age of credit history will reduce, and your credit score would be affected.
That being said, if you have a loan that you can foreclose, it is suggested you do so. Even though age of your credit history will have an impact on your credit score, your repayment history has much more weightage than your average credit history age. So, if you want to foreclose your loan, you should do that.
Last Word
Some people think that staying away from loans and credit cards is a good financial decision. Hence, for a long period of time in life, they may not have taken a credit. Suddenly, when all hell breaks loose, taking a loan could be costly as you have no credit history. One should understand the importance of credit score and get started with maintaining it as early as possible to reap its benefits in the future.