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What is a credit score?

In simple words, your credit score is a measure of your credit strength. It is actually a simple number that firms use to better understand the risk they are taking on when doing business with you. Usually, your ‘typical’ credit score is a number between 300 and 850, 300 being ‘poor’ and 850 being ‘excellent’ in terms of the credit strength. Thus, higher your credit score, higher the confidence a firm will have in you that you will be willing and able to live up to terms of an agreement, usually for credit. As a rule of thumb, it is always advised to keep your credit score above 740. A credit score below 650 will result in fewer chances in qualifying for loans and even if you qualify, the rate of interest would be very high.

Your credit score is calculated based on many measures. Fair Isaac, the founder of the credit score is has provided some guidance on this but the exact algorithm for generating the credit score is their proprietary information. Nevertheless, a set of weights which contributes towards the credit score is made visible. They are respectively,

  • 35% Payment History
  • 30% Credit Utilization
  • 15% Account Age
  • 10% Credit Inquiries
  • 10% Account Mix/Total

Thus, the two major factors affecting the credit score are your payment history and credit utilization. Payment history is simply the history of your loans. This is a measure of how well you have been paying your debts as noted in your credit reports. Credit utilization denotes the utilization ratio or the fraction of the amount which you are currently using out of the total available debt (revolving credit). The three minor factors would be the account age – i.e. the age of your account history, credit inquiries – i.e. how willing you are to open new accounts, and account mix – i.e. the mix of credit tools you are utilizing. Improving all these factors will lead you to a higher credit score and lower cost of living.

Why is it important to improve your credit score? This is the main problem that many younger consumers do not fully appreciate. At first glance, your credit score can support you to borrow money effortlessly. However, there is a whole new significance behind this simple numerical value. Your credit score can affect your insurance premiums. In many parts of the world, the credit score is an indicator of insurance premium where higher the credit score, lower the premium you pay. In addition, it has also become a mode of extra benefits such as obtaining uninterrupted TV, cable and cell phones services. In certain occasions, you might be denied such services due to having a low credit score, unless additional deposit or expenses are incurred, whereas having a high credit score would result in you obtaining easier access. Best of all, when you have a high credit score, you will definitely have access to better and more convenient financial deals. Many banks and other firms provide incentives to consumers with higher credit score such as no fee checking accounts, investment accounts, and credit cards. Thus, having a higher credit score would make your life easier in the long run.

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