India boasts of a large financial sector consisting of more than 900 banks and financial institutions which offer different kinds of credit facilities and loans to borrowers. While lending a credit facility such as a loan, how do these banks and institutions check the borrower’s creditworthiness? The answer is, through an individual’s credit score.
As soon as a borrower applies for a loan or other form of credit, the lender or bank checks his/her credit score. Hence, a good credit score is very crucial to easily get a loan at reasonable credit terms.
Many factors affect a credit score. Here, we will discuss the top 5 factors affecting the credit score.
What is a Credit Score?
A credit score is a 3-digit number that ranges between 300 and 900. It acts as a summary of a borrower’s credit history and overall creditworthiness.
A credit score above 750 is considered a good score and lenders generally prefer this higher credit score, i.e., a score between 750 – 900. For a borrower, it also improves the chances of easily getting a loan or other credit facility at reasonable terms.
What Factor Has the Biggest Impact on Credit Score?
A credit score is usually affected by many factors. Here, we will highlight the top 5 factors that affect credit score:
A borrower’s credit score is, to a great extent, a reflection of the timeliness followed with regards to repaying loans or credit card bill payments. Defaults in credit card bill payments or loan repayments can negatively affect one’s credit score. The longer one takes to repay credit card bills and the greater the number of unpaid bills, the higher the negative impact on credit score. Repayment history makes up approximately 30% of a credit score. Hence, it is important to keep a track of one’s repayment due dates and preferably never miss a due date to ensure a good credit score.
Credit utilization is an important factor that affects credit score since it accounts for at least 25% of the credit score. If a borrower has been consistently displaying poor spending habits, like spending beyond his/her means, it can result in a higher credit utilisation ratio. This can negatively affect his/her credit score. This is because lenders consider a higher credit utilisation as irresponsible financial behaviour on part of the borrower.
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Number of Credit Inquiries
Lenders often run a hard check on a borrower’s credit report whenever there is an inquiry or new credit card or loan. The hard check is mainly performed to gauge the borrower’s repayment ability and can therefore be a determining factor as far as loan approval is concerned. When an individual applies for credit cards or loans with multiple institutions, it indicates credit hungry behaviour on his/her part. The main concern of lenders is to ensure timely recovery of the funds lent. Thus, aggressive applications for credit cards or loans with multiple lenders can create a poor impression and indicate that the borrower may not be able to service the loan repayment as per the lender’ expectations.
A credit score is generally impacted up to 20% with multiple credit inquiries made to multiple lenders.
Length of Credit History
Banks usually have a detailed record of the borrower's credit history. Potential lenders also access a detailed credit report to get an idea about credit history and usage. Long and good credit history has a positive influence on a borrower’s credit score and helps in easily availing credit. Lending institutions prefer a positive and consistent repayment track record and it may therefore be a good idea to avoid closing an old credit card even if it is not required any longer. Closing old credit cards could result in a drop in the credit score.
Additional Read: How can credit cards help in improving credit score?
The credit mix used by a borrower comprising both secured and unsecured loans is considered ideal by lenders. A secured loan requires the borrower to pledge any asset to avail of the loan. These loans include home loans, car loans etc. Unsecured loans do not require any collateral, for example, personal loans. Borrowing different types of credit and repaying on time can build trust with the lender and impacts the credit score of the borrower.
Borrowers must access a copy of their credit report at least once a year and check whether it is error-free. It is important for borrowers to continuously work towards building and retaining a healthy credit score so that they can have better capability to negotiate lending terms in the future.
A good credit score can ensure easy availability of credit for borrowers who want to fulfil personal financial needs. Before availing any form of credit, borrowers must carefully consider all the factors that affect their credit score, positively and negatively. This can help in working towards a good credit score and availing better credit terms.
- What are two factors used to determine a credit score?
The credit history and repayment pattern of a borrower are two of the main factors that help in determining a credit score. However, note that there are other factors beyond these two that impact your credit score and rating.
- What is a good credit score in India?
A good credit score can range anywhere between 750-900.
- How can I get a 750-credit score?
To get a good credit score, i.e., above 750, a borrower must work towards aspects like a good repayment track record, lower credit utilisation ratio, consistent credit behaviour, and longer credit history, to name a few.
- What factors affect your credit score?
Some of the factors that affect your credit score are repayment history, credit behaviour, credit utilisation ratio, credit inquiries, etc.
- How can I raise my credit score overnight?
To increase your credit score in a short period, you can access your credit report and check for its accuracy. Sometimes, if the details in the report are inaccurate, it could result in a lower score. This can be raised with the credit bureau and immediate rectification can be sought.