How is Credit Score Calculated? A Simple Guide to Understanding the Number
Your credit score is like a report card for your financial habits. It tells lenders how responsible you are with money, especially when it comes to borrowing and repaying. If you’ve ever wondered, “How is credit score calculated?” or “How is credit score computed?”, you’re not alone. The process may sound technical, but the main factors are actually quite straightforward.
Here’s a clear, simple breakdown of the main elements that go into credit score calculation and how you can improve yours.
1. How Many Accounts Are in Your Name?
One of the first factors affecting your credit score is the total number of credit accounts you have. These can include credit cards, personal loans, car loans, home loans, or even smaller credit lines.
Having multiple accounts isn’t bad. In fact, having a healthy mix can sometimes work in your favour. However, if you’ve opened too many new accounts in a short period, it could signal to lenders that you are taking on more debt than you can handle.
When assessing your score, credit agencies look for:
- How many accounts do you currently hold?
- The ratio of active to closed accounts.
- Whether your accounts have a positive repayment history.
You don’t need to close old accounts that are in good standing; keeping them active can sometimes help your score. You can always check your credit score online to see how your account numbers are impacting your rating.
2. Your Credit Mix Matters
It’s not just the number of accounts that counts; it’s the types of credit you hold. Broadly, there are two main kinds:
When assessing your score, credit agencies look for:
- Revolving credit, such as credit cards, where you have a set limit and can borrow repeatedly as long as you make repayments.
- Instalment credit, such as loans with fixed monthly payments until the debt is cleared.
A balanced mix of both can demonstrate that you’re capable of managing different forms of credit responsibly. If all your credit is of one type, say, only credit cards, it might not give a full picture of your repayment ability.
You don’t have to take unnecessary loans to improve your mix. Instead, focus on maintaining the accounts you already have and ensuring timely repayments.
3. How Much Credit You’re Using vs. How Much You Have
This is one of the biggest factors affecting credit scores. It’s called your credit utilisation ratio, and it measures how much of your available credit you’re using.
For example:
If your total credit limit is ₹1,00,000 and you’re using ₹60,000, your usage is 60%.
A high ratio can lower your score because it suggests you may be over-reliant on credit. Most experts recommend keeping your utilisation below 30% for the best results.
4. How Long You’ve Been Building Credit
Your credit history is a record of how long you’ve been using credit. A longer history usually helps because it gives a bigger picture of your financial habits over time.
If you’re just starting out, your score might be lower. It’s not because you’ve done anything wrong, but because there’s less data to work with. On the other hand, someone who has been responsibly managing accounts for 10+ years will generally look more reliable.
Think twice before closing your oldest credit account. Even if you don’t use it often, the age of that account adds to your overall history.
5. Your Payment Habits Say It All
When it comes to how a credit score is calculated, your payment history often has the largest impact. This is simply a record of whether you’ve paid your bills on time. Even one missed payment can lower your score and stay on your record for years.
Lenders like to see a consistent pattern of timely payments because it shows you’re dependable. It’s not just loans and credit cards; missed payments on things like utility bills or EMIs can also be reported.
Set up payment reminders or auto-debits so you never miss a due date. Even paying the minimum amount on a credit card is better than missing the payment entirely.
Final Thoughts: Credit Score Calculation Reflects Your Habits
Your credit score isn’t just a random number; it’s a reflection of your financial habits over time. The elements, such as the number of accounts, types of credit, utilisation ratio, length of history, and payment record, collectively determine how a credit score is computed.
If you want to improve your score:
- Keep your credit utilisation low.
- Pay bills on time.
- Maintain older accounts.
- Aim for a balanced credit mix.
- Monitor your score regularly.
Thanks to technology, you can now check your credit score online for free or at a minimal cost, helping you track your progress and make smarter financial choices.
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