Explained: What is a credit score, why is it important & how to improve it

What is a credit score?

A credit score indicates a person’s ability to repay a borrowed amount. It is a three-digit number in the range of 300 to 900. A credit score closer to 900 indicates that a person is more likely to pay off the loans on time while a lower score indicates that the person is likely to default on the borrowed amount. In short, the number depicts the creditworthiness of a person.

What is the importance of a credit score?

A credit score is among the first things a financial institution would check in order to sanction a loan. A better credit score not only makes it easy for a person to borrow but also makes him/her eligible for a higher loan amount. Besides, it helps the person get loans at lower interest rates as he is considered less likely to default.

Factors involved in calculating the credit score

A credit bureau considers the following factors to calculate the credit score:

Payment history

Payment history contains details such as the number of loans availed by the person, the time taken to repay them, and timeliness in paying interest.

Credit utilisation ratio

It shows the amount of revolving credit available on all the credit cards used by a person. The lower the credit utilisation ratio, the higher the credit score.

Credit mix

It shows the types of credit availed by a person, such as loans, mortgages, credit cards etc. The credit mix depicts how a person has managed his accounts over time.

New credits and approvals

This indicates the number of loans applied for by a person over a period of time. If there are more loan rejections, the credit score is adversely affected.

What is a good credit score?

Any number above 650 on a scale of 300-900 is considered a good credit score. The higher the credit score, the easier it is for a person to get loans, credit cards etc, from financial institutions.

But if a person’s credit score is closer to 350, it indicates that the person is more likely to default on the loan. A lower credit score makes it harder to receive a higher loan amount and also draws a higher rate of interest from the lender. A credit score between 350 and 549 is rated poor, a score between 550 and 649 is rated average, a score between 650 and 749 is considered good and a score above 749 is considered excellent.

How to improve your credit card score

It is important to maintain a higher credit score in order to avail of credit facilities. But if stuck with a lower credit score, a person can fix it in the following ways.

Timely repayment

It is important to pay outstanding bills, equated monthly instalments (EMI) and credit interests on time. Delayed repayments would invite a penalty that negatively impacts the credit score.

Credit utilisation

Maintaining a credit utilisation ratio below 30 per cent would help in increasing the credit score. Using the fully available credit shows the dependence of a person on credit money and makes him riskier for a bank. Lower the credit usage, the better the credit score.

Number of loans availed

Taking too many loans at a given point in time crashes the credit score. It is advisable to manage finances to repay the open loans in a timely manner before availing further loans.

Check credit report

A credit report contains a person’s credit activity, open loans, repayment status, etc, which can show the person’s past mistakes and helps in not repeating them.

Number of credit inquires

Reducing the number of credit inquiries, i.e. the number of times a person would inquire about a loan from a financial institution helps increase the credit score. Several inquiries made in a short span of time indicate poorer financial management and make the person riskier to credit loans.

Longer loan tenures

Choosing a longer tenure for loan repayment helps in reducing the amount of EMIs, which helps in timely repayment and also helps avail higher loan credits.

Removing old accounts

Removing old accounts or debt history after repayment impacts the credit score negatively. It is advisable to not remove credit history as old records are automatically deleted after a certain period of time.

How to check your credit score?

In India, credit scores are provided by the credit rating agency, Credit Information Bureau (India) Ltd (CIBIL). One can check the credit score by:

Step 1: Go to CIBIL’s official website

Step 2: Choose the ‘Get free CIBIL score and report’ option

Step 3: Fill the personal information page and click the ‘Accept and continue' option

Step 4: Enter the OTP received on your phone number to complete the verification

Step 5: Click the ‘Go to dashboard’ button. This step would direct the user to the myscore.cibil.com website

Step 6: Click on ‘Member login.’ Once logged in, the user can access the CIBIL score.