Each one of us needs a bank loan for one reason or another. A credit card is also a form of loan or credit from the credit card issuing bank that allows you to spend the money first and then pay the bank later. Before approving a credit card or loan request, the banks need to make sure that you have a good track record of paying back. Banks get this assurance from your credit history, which is a record of your past borrowing and repaying activities. Many employers, before offering you a job, also look at your credit history to assess your fiscal discipline.
Credit history is tracked by 3 independent credit reporting agencies: Equifax, TransUnion, and Experian. These agencies regularly collect credit history of all individuals from financial institutions country wide.
Credit score represents your credit worthiness and ranges from 300, a worst case scenario, to 850, a best case scenario. Having a higher score helps you get bank loans at lower interest rates. Earlier a score of 700 and above was considered to be a good score. But in the aftermath of financial services crisis of 2008, banks have become more cautious and consider a score of 750 and above to be good. Most banks ( creditors ) rely on your credit history from one or more of these agencies. At the time of reviewing your request, banks use a formula to convert your credit history into credit score. The formula for this score is developed by Fair Issac Corporation. Although the three credit rating agencies use their own proprietary score, they all follow broadly the same set of factors. Broadly speaking there are five factors that go in the calculation of credit score.
About 10% weight is given to new credits i.e. how many new credit requests hit your credit history or how many new accounts were opened.
Have a higher credit limit: Having a higher credit limit on your credit card accounts or home equity line of credit account and not using it completely increases your score. Although, you don't want to open too many accounts as it becomes difficult to manage and in some cases a creditor may charge you an inactivity fee. Many of us tend to close the accounts as soon as we stop using them. It might pay to keep them open. But guard these accounts or unused credit cards to avoid any fraudulent activity in your account.
Pay bills on time: This is a very important factor in credit scoring and carries about 1/3 of the weight in your credit score. At least pay the minimum payment required from you. In the revised FICO formula, payment history plays even bigger role. In case your payment got delayed for some reason, it is a good idea to talk to your bank. If this was an occasional delay and was not more than a certain number of days, the bank may comply with your request and not mark it as a late payment.
Minimize the number of inquiries against your credit history. There are two types of inquiries. A hard hit against your credit history for a loan application can easily knock off 15 points. A soft hit is for inquiries by various finance institutions and banks on your credit history on a periodic basis. This helps them determine whether to send you offers for credit cards or other loans. Inquiries for multiple loans e.g. mortgage, education loan, and car loan within a 2 week period is considered to be one. For one particular loan, multiple inquiries (hard hits) within past 30 days is counted as one. So, planning such loans around the same time benefits your credit score.
Try not to use more than 50% of your credit limit.
Always pay your bills on time. Even one late payment (over 30 days) can knock off 50-100 points. If you were late on one payment a few subsequent timely payments can help you win back a lion's share of lost points.
If your credit card balances run higher (as a percentage of your credit limit) and you are looking for a new loan, try to cut back on the use of your credit cards for a few months to improve your credit score.
To help your teenage children build their history, guide them on careful use of loaned money and add them as authorized users on your credit card so that they can get a leg up in building their own credit history.
