What is a Credit Score?
A credit Score is a standardized mathematical number which depicts the credit worthiness of a consumer. The first credit score was invented in 1959 by engineer Bill Fair in partnership with mathematician Earl Isaac who formed a company by the name Fair, Isaac and Company which currently goes by the name Fair Isaac Corporation (FICO).
The FICO credit score ranges between 300-850 helping lenders in making lending decision. A high credit score indicates a lower credit risk or a lower probability to default while a lower grade indicates a higher risks implying denial for credit or expensive interest rate on the borrower. FICO score implies the following:
- 800+: Exceptional borrower
- 740-800: Very good
- 670-740: Good
- 580- 670: Fair
- 300- 580: poor
How to calculate a credit Score
Credit score is calculated by considering payment history, total amount owed, length of credit history, type of credit and the new credit requested. Credit score depend on historical data and therefore individuals who have never taken credit have no credit score. The factors used by FICO are calculated as follows:
- Payment History contributes 35%, timeliness in repayment of loans on time.
- Credit Utilization contributes 30%
- Credit history is allocated 15%, customers with long credit history and good payment behaviour are highly scored.
- Credit Mix 10%, for customers with a mix of credit products like credit cards, auto loans, mortgage etc.
- New credit is given 10%, checks on how many requests the client has submitted in a short period of time. Every time a borrower makes a credit application they get flagged and may affect the customer rating.
- Length of credit History
- Current indebtedness or amounts owed to others in relation to the income of the borrower.
How to improve your Credit Score
A bad credit score can negatively affect a consumer financial ability by being denied a line of credit for being perceived as high risk. However borrowers with a bad credit score can improve their credit score in the following ways:
- Borrowing and paying on time to build a credit history.
- Ensure timely repayment towards your loan without delay or missing on our repayment.
- Maintain your credit limit on all your lines of credit.
- Maintain a low debt ration to avoid challenges in repaying the loan.
- Ensure you have a steady source of income when applying for credit to avoid failure on repayment.
- Avoid holding many credit cards making you rely on debts which may lead to a lower score.
Credit reports issued by Credit Reference Bureaus contains an individual credit score based on whether they have ever borrowed. Therefore it is advisable to access your credit report at least once annually to keep track of your credit score. With introduction of Risk Based pricing, consumers with a good credit score are likely to access credit at a favorable price.