The importance of credit score has increased manifolds in recent times. This three digit number is like a performance measure that indicates how well you have handled your debts in the past. Whenever you apply for a loan or a credit card, lenders pull your score to ascertain whether you are worthy of giving credit. A high score means that your loan applications will easily be approved and you can bargain for low interest rates and better terms.
Since this number plays a crucial role in your financial life, you must pay attention to building a solid credit history. For this you need to understand the parameters that determine your credit score. If you have a low CIBIL score, then working on these parameters will help you in rebuilding credit.
Though the exact scoring model of the credit bureaus is not known, there are primarily 5 main factors that determine your score.
1. Payment history
The most heavily weighted factor in the CIBIL score calculation is your payment behaviour. If you consistently make on time payments of your EMIs and credit card bills, you will have a strong credit score. In fact it is the best way to ensure that your credit is in good health. It portrays that you are a reliable borrower who will honour the commitments in a timely fashion.
Late payments on the other hand hurt your score badly. Payments that are more than 30 days overdue are reported to the bureau. If you go without paying for more than 60 days the impact can be seriously damaging. Credit scoring models look into how late the payments were made, how much you owe, how often you miss your payment and how the recent payment activity has been. Once your account is sent for collections, the negative information will have a tremendous impact on your score.
Derogatory remarks like bankruptcy, foreclosure and liens have a serious impact on your credit score. It will severely reduce the chances of getting approved for new credit.
The second factor that determines your credit score is the percentage of the credit line that you are using on the revolving lines of credit (like credit cards). If you have a low CIBIL score inspite of making timely payments, then credit utilization ratio might be one of the reasons. It is calculated by dividing your credit card statement balances by the total credit limit. As a practice try to ensure that this ratio never exceeds 30%. The fact that you are not using a lot of the credit limit available to you shows that you are not overly dependent on credit.
3. Age of accounts
The average age of accounts plays an important role in CIBIL score calculation. A longer period of your experience in handling credit helps lenders to accurately assess your credit worthiness. Old accounts with good credit standing help in raising your CIBIL score. That is why it is always recommended to start building credit by using credit cards as soon as you land your first job. The sooner you start the better it is for your score. Also do not close your old credit card accounts. It will shorten the average length of open credit lines and also reduce your total available credit, thereby increasing utilization ratio.
4. Account Diversity
Lenders like to see diversity in your experience in handling different kinds of credit accounts. If you have a good mix of revolving and instalment loans in your credit mix you will earn more points during the CIBIL score calculation. Revolving credit like credit cards have varying payments every month and the unpaid balance is carried to the next month. In instalment accounts like personal loans, car loans, home loans a fixed amount has to paid every month for a fixed period of time. Your ability to handle both these kinds of debts responsibly will contribute to your credit worthiness.
5. New credit
The credit scoring models also take into account the number of new credit lines that you have opened. Before approving any new line of credit lenders pull your credit report to check your past behaviour. This creates a hard enquiry on the credit report. A no. of credit application in the recent past will indicate a credit hungry behaviour and lower your score. Hence do not apply for several lines of credit all at once.
So now that you know about the parameters that affect the calculation of the credit score you can work on them to improve your low CIBIL score. These guiding principles will help you work proactively towards a strong credit profile.