What is a Credit Score - Meaning, Importants and its Calculation

Your credit score can sometimes turn out to be a very important number for you; it summarizes your financial health from a creditworthiness perspective. The score can have a significant impact on your financials as it is studied very closely by potential lenders when determining the credit to offer you. Having a strong credit score helps you enjoy the best of loans as well as credit cards.

This three digit number is more important than any as it shows how likely you are to repay your debts on time. A high score shows that you pay your debt on time, whereas a low score shows a low likelihood of repayment. Thus, a low score will get you credit at a higher interest rate, while a high score might get you access to low interest rate loans.

The credit score is computed by credit bureaus like CIBIL, Experion, Crif Himark etc.

In this article, we will take you through the basics of credit score calculations, the importance of the scores, finally, how you can improve your score to enjoy the many affiliated benefits. Read on!

What is a Credit Score?

A credit score is a three-digit number that provides lenders with an indication of a borrower's ability to repay borrowed money. It plays an important part in determining credit terms and interest rates.

Now that you know what a credit score is, you may wonder how it is calculated.  Equifax calculates credit scores based on data, which includes a credit report that considers payment history, credit utilisation rate, revolving credit, and recent credit inquiries. A higher credit score (of 700 or higher) means there is a lower risk of default, and this makes it easier to access available credit. Be sure to manage debt and keep your credit utilisation rate low, as it could affect your credit score.  It is essential to manage debt responsibly and keep your credit utilisation rate low, as it can impact your credit score.

What Are the Credit Score Ranges?

Credit scores typically fall within specific ranges, which provide a snapshot of an individual's creditworthiness. The most commonly used credit scoring model is the CIBIL score, which ranges from 300 to 900. Here is a breakdown of the credit score ranges and their corresponding levels of creditworthiness, so you know what is my credit score when you check the same:

How Did Credit Scores Work?

Credit scores are calculated based on complex algorithms that assess an individual's credit, credit utilisation rate, and financial behaviour. The two most common credit scoring models are the CIBIL score and the Experian score. These models consider various factors, such as payment history, credit utilisation rate, length of credit history, types of credit, revolving credit, and recent credit inquiries. Each factor carries a different weight in the calculation, with payment history usually being the most influential.

Paying your bills on time, using only a small portion of your available credit, and having different types of credit can help improve your score. On the other hand, carrying high credit card balances or missing payments can lower your score. Lenders use this report to evaluate an applicant's credit standing and determine the level of risk involved in extending credit terms. Paying your bills on time and keeping good credit habits can help you maintain a healthy credit score of 750 or higher, which is usually considered good and makes it easier to qualify for loans.

How Is a Credit Score Calculated?

All credit bureaus have their own metrics for developing the scores of individuals, though the basic methodology generally remains the same. Each bureau comes up with certain key attributes and assigns certain weights to each. Then using historical behavior exihibited by the individuals, the individuals are scored on each of these attributes. To develop the final credit score, the scores against each attribute is aggregated using the pre-assigned weights.

Listed below are some key attributes which are used for credit scoring:

1. Payment history: Payment history is the first thing a lender will want to know about you. It provides information about the past loans that you may have borrowed and also reflects on your ability to repay in the future. Prepayments or on-time payments help increase the score on this attribute.
2. Amount owed: The next important information is the amount you owe. It does not necessarily mean that you have a low credit score if you owe a large amount. Though, having too many loans concurrently is not advisable, as lenders see it as risky and avoid lending.
3. Length of credit history: It is believed that a longer credit history leads to a higher credit score. Although, people who do not have a long credit history can also hold a high score based on other aspects of the report. The length takes into consideration the duration of the specific credit accounts, the time period since you used them and the duration since the accounts have been established.
4. Credit mix in use: Various credit mix in use, may include, mortgage loans, retail accounts, credit cards, installment loans, and finance company accounts. The entire mix forms your credit report based on which the credit score is determined.
5. New Credit: The opening of a large number of credit accounts at the same time demonstrates that the individual is a potentially high risk and indicates propensity towards fraudulent behavior. Thus, it is advisable to not open a lot of new accounts rapidly, shopping for new credit should be delayed until the current borrowings are paid off.

How to Check Your Credit  Score Online?

Checking your credit score online has become a convenient and simple process. To access your credit score, follow these steps:

• Visit the official website of a reputable credit bureau, such as CIBIL (Credit Information Bureau India Limited).
• Look for the "Check Your Credit Score" or similar option on the website's homepage.
• Click on the link and provide the necessary details, including your name, date of birth, address, and identification information.
• Authenticate your identity through the verification process, which may include answering security questions or providing documentation.
• Once verified, you will be able to view your credit score and credit report.
• Review your credit report for accuracy and check for any discrepancies or errors that may impact your creditworthiness.

Take note of the factors contributing to your credit score and areas that need improvement.
Remember to check your credit score regularly to stay informed about your financial standing and take steps to maintain or improve it.

Why Is a Credit Score Important?

• Easier Access to Funding: One of the major advantages of having a good credit score is that you can more easily get loans and credit. Your credit score is the benchmark used by banks and other financial institutions to decide whether or not to grant you the funds you are seeking. Generally speaking, a credit score of 700 or higher is good, and this can make it easier for you to get a home loan, a credit card, a personal loan, or any other type of loan. 
• Favourable Loan Structuring: Having a credit score helps you secure the loan with the most favourable terms, regardless of the loan tenure, whether short-term, medium-term, or long-term.
• Lower Interest Rates: A good credit score enables you to take advantage of lower interest rates for both secured and unsecured loans.
• Greater Negotiating Power: Having a good credit score means that you can have more negotiating power with banks or financial institutions. A good credit report is your ticket to better credit terms as well as lower interest rates.
• Security Deposits May Not Be Required: The majority of loans come with a security deposit, the size of which depends on the amount of credit that you wish to take. In the case of a good credit score, you are not required to pay a deposit at all.
• Higher Limits: A good credit score allows you to access higher credit limits and also facilitates the building of your overall credit.
• Lower Processing Fees and Other Charges: If you have a good credit score, then the banks and financial institutions will be more willing to offer you lower processing fees and other charges.
• Long-Term Benefit: In case you do not need a loan at the moment, a credit score of 750 will be of great help at a later stage. Not only does this make the process of obtaining a home loan much smoother, but in the case of renting, a good credit score can also facilitate the process.

How to Improve Your Credit Score

1. Know your current score: The first step to improving a credit score is by knowing the score you hold. Check your credit score on the various credit bureau’s websites and see where you are standing.
2. Resolve credit report discrepancies: Your credit report will display the score and help you gain an insight into any discrepancies present. To resolve the same, you need to follow up with the lender and make sure any errors are immediately rectified and the information updated.
3. Try and consolidate debt: This will make it easy for you to repay and also put an end to the hassle of remembering different dates of repayment. If you have two or three loans running concurrently, you can consolidate it into one.
4. Clear existing debt: The easiest way to improve the credit score is by clearing the debt. Do not let the debt pile up, instead begin with clearing the small loans. If you have overdue credit card bills, repay them and move to other loans. Unpaid balance will keep adding on interest and it will have a negative impact on your credit score.
5. Don't withdraw cash using a credit card: Avoid using the credit card for cash withdrawals, as it shows that you are unable to live within your means. This is a red flagfor many lenders.
6. Only seek funds if you need them: Unnecessary opening of credit accounts leads to a negative impact on your score. Every loan application means an additional burden of repayment and affects the credit score.

Difference Between Credit Score & Credit Report?

While related, credit scores and credit reports serve different purposes in assessing an individual's creditworthiness. Here's a breakdown of the key differences:

Benefits of Having a Good Credit Score

Maintaining a good credit score brings several advantages and opportunities. Here are the key benefits:

• Access to Better Loan Terms: A good credit score makes it easier to secure loans with favourable interest rates, repayment terms, and higher borrowing limits.
• Lower Interest Rates: Lenders are more likely to offer lower interest rates on mortgages, auto loans, and credit cards to individuals with good credit scores, resulting in significant savings over time.
• Higher Approval Rates: With a good credit score, you have a higher chance of getting approved for credit applications, including loans.
• Negotiating Power: A good credit score gives you leverage when negotiating terms with lenders, allowing you to request better rates or terms. 

Maintaining a good credit score opens doors to financial flexibility, favourable terms, and better opportunities in various aspects of loan life.

Holding a good credit score is highly important from a financial management perspective. It is essential to be aware about how the score is calculated so that you can either maintain the good credit score or work towards a better score through various ways. Remember maintaining good spending habits will help in a good credit score, this will go a long way in wealth creation.

Frequently Asked Questions

1. What is considered a good credit score?

A credit score of 750 or higher is generally considered good and increases the likelihood of favourable credit terms.

2. Credit score 0 means?

A credit score of 0 typically indicates a lack of credit history or insufficient credit information to generate a score.

3. How long does it take to build credit?

Building credit takes time and consistent positive credit behaviour. It generally takes several months to a few years to establish a solid credit history.

4. Can my credit score be affected by someone else's actions?

No, your credit score is not directly affected by someone else's actions unless you have joint accounts or shared financial obligations.

5. How often should I check my credit score?

It is recommended to check your credit score at least once a year, or before major financial decisions, such as applying for a loan or credit card.

6. What steps should I take if I find errors on my credit report?

If you find errors on your credit report, you should notify the credit bureau in writing, provide supporting documentation, and request a correction or removal of the inaccuracies.

7. What are the 5 C's in credit score?

The 5 C's in credit score are Character, Capacity, Capital, Collateral, and Conditions. These factors help lenders evaluate a borrower's creditworthiness.