A credit score is a numerical expression based on an analysis of a person’s credit history, to represent the creditworthiness of that person. A credit score is primarily based on credit report information typically sourced from credit rating agencies.
Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk to which they are exposed to by lending money to consumers. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and the amount of loan that can be granted to them. Lenders also use credit scores to determine which customers are likely to bring in the most revenue and fund based income to banks.
Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, landlords, and government departments employ the same techniques. Credit scoring also has much overlap with data mining, which uses many similar techniques and database records.
Credit Rating Methodology in India
In India, there are four credit information companies licensed by Reserve Bank of India. The Credit Information Bureau (India) Limited (CIBIL) has functioned as a Credit Information Company from January 2001. Subsequently in 2010, Experian, Equifax and Highmark were given licenses by Reserve Bank of India to operate as Credit Information Companies in India.
Although all the four credit information companies have developed their individual credit scores, the most popular is CIBIL credit score. The CIBIL credit score is a three-digit number that represents a summary of individuals’ credit history and credit rating. This score ranges from 300 to 900, with 900 being the best score. Individuals with no credit history will have a score of -1. If the credit history is less than six months, the score will be 0. CIBIL credit score takes time to build up and usually it takes between 18 and 36 months of credit usage to obtain a satisfactory credit score.
Some of the most common credit rating agencies are CIBIL , CRISIL, Moody’s,Fitch, Standards & Poor’s,ICRA etc.
How is the Credit Score calculated??
The credit score, commonly referred to as a FICO score, is a proprietary tool created by the Fair Isaac Corporation. This is not the only way to get a credit score, but the FICO score is the measure that is most commonly used by lenders to determine the risk involved in a particular loan.
Due to the proprietary nature of the FICO score, the Fair Isaac company does not reveal the exact formula it uses to compute this number. However, what is known is that the calculation is broken into five major categories with varying levels of importance. These categories, with weight in brackets, are payment history (35%), amount owed (30%), length of credit history (15%), new credit (10%) and type of credit used (10%). All of these categories are taken into account in your overall score – no one area or incident determines your score.
The payment history category reviews how well you have met your earlier financial commitments on various account types. It also looks for previous problems in your payment history such as bankruptcy, collections and delinquency. It takes into consideration the quantum of these problems, the time it took to resolve them, and how long it has been since the problems appeared. The more problems you have in your credit history, the weaker your credit score will be.
The next largest component is the amount that you currently owe to lenders. While this category focuses on your present amount of your liabilities, it also looks at the number of different accounts and the specific types of accounts that you hold. This area is focused on your present financial situation, and a large amount of debt from many sources will have an adverse effect on your score.
The other categories (length of credit history, new credit and type of credit used) are fairly straightforward. The longer you have a good credit history, the better. Someone who has never been late with payment over twenty years is a much safer bet than someone who has been on time for two. Also, people who apply for credit a lot probably already have financial pressures causing them to do so, so each time you apply for credit, your score gets dinged a little.
Your credit score is a key tool used by lending agencies, it is important that you maintain and improve it periodically.
How to rebuild your low credit score???
If you’ve ever run into financial trap , you know how frustrating it can be when that information shows up on your credit report. Lenders use the information on your credit report to assess your risk as a borrower, and delayed payments could make you seem like more of a risk. In addition, your credit score may be negatively affected.
Luckily, you have some control over your credit score. Just like missing payments and not paying your debts can bring down your score, you can do things to correct it. It takes some effort, but it is not impossible.
Understand what improves your score
The first is to understand what things build up your score. A credit score is based on several different factors in your credit history, including your payment history, how much you owe, how much credit is available to you, the period of your credit history, and the varieties of credit you are availing.
However, two things influence your credit score the most: on time payment of your bills and balance available in your account .
Keep your debt under control
Start with getting a handle on your payments and total debt. If it’s tough to keep up with credit card bills, call the card issuer to explain your situation and try to negotiate a payment you can afford. Once you have that in hand, try to keep a balance of less than 30 percent of your available credit limit.
The length of your credit history matters
You may want to avoid opening new credit accounts just to increase your available credit or applying for multiple credit cards over a short period of time. Either of these could have a negative effect on your credit score because of the impact of the length of your credit history.
Check your credit report
Start making a habit of reviewing your credit score and looking through your credit report regularly. You can get one free credit report each year from each of the three credit reporting bureaus through AnnualCreditReport.com. The site also lets you check your credit score for a small fee. Look for inaccurate information, and correct any mistakes if any. Checking your report can work as an early-warning system.
It takes time to rebuild your credit history and positively impact your score. Don’t get disheartened if your report doesn’t immediately reflect the work you’ve put into. Just be patient and continue working to gain more control over your finances.
In addition to keeping an eye on your credit balances and accounts, you may want to consider other methods of getting control of your personal finances, such as reducing household spending or creating a detailed budget.
You can also write a personal statement for your credit report. It won’t impact your score, but it can be read by anyone checking your credit report, from prospective employers to potential lenders.
With a little patience and discipline, you can positively impact your credit score and credit file. It will take time, but these steps can help you get control of your financial life.