A credit score is a numerical representation of an individual's creditworthiness. It is a measure of how likely someone is to repay borrowed money or fulfil financial obligations based on their past credit history.
Lenders, such as banks and credit card companies, use credit scores to assess the risk of lending money to individuals and to determine the terms and conditions of credit they offer.
Credit scores are typically generated by credit bureaus or credit reporting agencies, which collect and analyse data related to an individual's credit activities.
The most commonly used credit scoring models are FICO® Scores and VantageScore®. These scores range from 300 to 850, with higher scores indicating a lower credit risk.
Several factors influence credit scores, and each credit scoring model may weigh these factors differently. The primary factors considered in calculating credit scores include:
1. Payment history: This is the most significant factor and assesses whether you have made payments on time. Late payments, defaults, or delinquencies can have a negative impact on your credit score.
2. Credit utilisation: This factor measures the amount of credit you are using compared to your credit limits. Keeping your credit utilisation ratio low is generally beneficial for your credit score.
3. Length of credit history: This factor looks at how long you have been using credit. A longer credit history demonstrates a track record of responsible credit management and can positively impact your score.
4. Credit mix: Lenders like to see a mix of different types of credit accounts, such as credit cards, loans, and mortgages. Having a diverse credit portfolio can contribute to a higher credit score.
5. New credit inquiries: When you apply for new credit, such as a credit card or loan, it generates a hard inquiry on your credit report. Too many inquiries within a short period can indicate higher credit risk.
6. Negative marks: Bankruptcies, foreclosures, collections, and other negative items on your credit report can significantly lower your credit score.
It's important to note that each lender may have its own criteria for evaluating creditworthiness, and different lenders may use different credit scoring models.
Therefore, your credit score can vary depending on the scoring model and the lender's specific requirements.
Having a good credit score can open doors to favourable interest rates, better loan terms, and increased borrowing power.
It is essential to monitor your credit score regularly, review your credit reports for accuracy, and take steps to improve your credit if necessary.
By understanding how credit scores work and taking responsible financial actions, you can work towards achieving a higher credit score and improving your overall financial well-being.