How Your Credit Score is Calculated
One term consistently used in relation to your credit profile or loan application is your credit score. Your credit score is simply a numerical expression of detailed analysis of your creditworthiness. It reflects your ability to repay debts. A higher score signals better repayment capacity and lesser score makes you a risky borrower. Your credit score is calculated by three main credit bureaus; Equifax, Experian and TransUnion, which in turn is used by banks and credit card companies to evaluate customers.
How Your Credit Score is calculated?
Your credit score is derived from your credit reports. Most lenders furnish data of their customers to the credit bureaus, which compile the information in to ‘credit reports.’ Statistical analysis of the report is carried out and each bureau generates its own score. FICO model is the widely used method in calculating credit score. Fair Isaac Corporation (FICO) owns the proprietary rights for the software and technique in ascertaining the credit risk from your credit history.
Based on the FICO model, each of the credit bureaus has come up with their own version of credit score methodology. Equifax uses the BEACON score, Experian operates with the Experian/Fair Isaac Risk Model or PLUS, and TransUnion works with the FICO Risk Score. Information collected from various lenders is stored in credit files and forms the basis of their calculation of your credit score. Contradictory scores from different bureaus are often noticed, which is usually a result of incomplete information of your entire credit profile. Let’s look into what aspects of your credit history comprise your credit score:
- Payment History – This most crucial aspect contributes to 35% of your score. Payment of mortgage, credit cards, car loan, or any other bill payments on the due date is tracked. Your score can be higher if you make payments on time.
- Amount Due – This aspect constitutes 30% of score and your credit utilization against the sanctioned limit is noted. If the utilization is very high especially in case of revolving debts (credit cards) with no regular pay-offs, your scores tend to drop.
- Span of Credit History – Duration of your credit history covers 15% of your score. A relatively longer credit history implies a clean record and aides in improving your score.
- Types of Credit – Forming 10% of your score, the various types of credit in your credit profile viz., mortgages, revolving (credit cards), consumer finance, etc., reflects progress in your financial status and helps boost your score.
- Inquiries – The number of times your credit report was sought forms 10% of your score. Request for your credit report can be made either by you or your existing lender or any prospective lender. Numerous inquiries in a relatively shorter period, usually suggest that you are scouting for loans, which can be detrimental to your credit score.
A clean credit profile is the key to have a higher credit score, which not only enables you to certainly secure any loan in future but also aides in obtaining the loan at softer terms.