A credit score is a statistic that lenders use to evaluate the risk of loaning money to a specific borrower. Auto dealers, credit card companies and mortgage bankers conduct routine checks of your credit score before deciding on the quantum of loan and the interest rate to be applied.
Insurance companies, employers, and landlords evaluate the financial discipline by checking the credit score before issuing an insurance policy, offering a job, or renting out an apartment. Here are the four important credit score components that can influence your credit approval process and what it means when you apply for a loan.
1. Payment History: 35%
The crucial question lenders ask themselves when they consider a loan application is, “Will I get it back?” Credit score serves as a reliable guide to financial institutions to decide whether prospective borrowers can repay the funds. The following points are considered:
Have you paid the bills on time for each account on the credit report? Late payments have a negative effect on your score.
Have any accounts been referred to as debt collection? This is considered a red flag to prospective lenders that indicates that you might not pay them back.
2. Owed Amounts: 30 %
So you might be making regular payments, but what if you’re approaching a breaking point? Credit utilization of the individual refers to the quantum of acquired debt compared to the availed credit limits. This component assimilates the following factors:
How much of the total available credit has been used? Less is better, but owing a little debt is beneficial when compared to owing nothing.
How much do you owe in particular types of accounts such as credit cards, auto loans?
What is the total amount that you owe and what is the share of the owed amount when compared to the original amount on term instalment accounts?
3. Extent of Credit History: 15%
Your credit score is calculated depending on how long the credit account is open. Long credit history is certainly helpful, provided that it’s not downgraded with late payments. Short credit history is also acceptable when the payments are made on time and the debt is within reasonable levels.
Persona financial experts suggest getting a free credit score check to evaluate the creditworthiness before applying for a loan. By leaving the credit card accounts open, the age of the account is increased, which boosts the credit score. Closure of oldest accounts leaders to a decline in credit score.
4. New Credit: 10%
A credit score check involves evaluating the number of new accounts that were applied for and the last time a new account was actually opened. Lenders conduct a hard inquiry known as a hard full when a new credit application is made. Hard pulls cause a negligible and temporary decline in your credit score. Individuals who open a large number of accounts in recent times are prone to a greater credit risk as they may be experiencing cash flow problems or planning to assume lots of new debt.
The Bottom Line
Getting a free credit score check is extremely vital in getting loan approval and the best interest rates. Making better financial choices will reflect in a gradual improvement in the credit score.
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