What is a Credit score? Range, Function & How to Improve

A credit score is a number that shows the creditworthiness of a person. The score ranges from 300 to 850, where a higher score means a person is worthy of credit. It also represents that a person can easily get loans at better rates.

A credit score is calculated on the basis of credit history, debt utilization, types of loans, credit files across different loan types, length of credit history, and application for a new account.

• The FICO and VantageScore are two important credit scores.
• According to FICO, a credit score ranges from 300 to 850.
• Timely repayment and credit utilization are the important factors that impact the credit score.
• A credit score is an important part of your financial life. It ensures whether you will get a loan and at what rate. It also ensures whether you will own a credit card or not.
• The US has three major credit bureaus: Equifax, Experian, and TransUnion.

The credit score is calculated on the basis of information in the credit accounts. The credit reporting agencies make a credit report.

What is a bad and good credit score?

A credit score is divided into five parts and ranked from excellent to poor.

According to FICO, the credit score is calculated in the following categories:

1. Poor credit score: 300–579
2. Fair credit score: 580-669
3. Good credit score: 670-739
4. Very good credit score: 740–799
5. Excellent credit score: 800-850

According to VantageScore, the following categories represent good and bad credit scores:

• Very poor score: 300–499
• Poor score: 500-600
• Fair score: 601-660
• Good score: 661–780
• Excellent score: 781-850

How does Credit score work?

A good credit score is favorable in many ways as it directly impacts a person's financial life. The lender depends on the credit score to check the creditworthiness of a person. If you have a high credit score, you are good to get a loan at a reasonable rate. It helps you to save money in the long term.

The reporting agencies in the US make a credit report for the consumer. To do so, they use five basic criteria.

1. Payment History: It shows the late payments and how late they were. It makes up 35% of the credit score.

2. Amount Owed: The amount the consumer uses compared to the available credit makes up 30% of the credit score.

3. Length of credit history: A longer credit history gives more information about the payment history; hence, it is risky. It makes up up to 15% of the credit score.

4. Credit mix: It shows various types of credit and the capacity of the consumer to manage them, like installment credits, different types of loans, etc. It makes up to 10% of the credit score.

5. New Credit: Recent credit applications negatively impact the credit score. It makes up 10% of the credit score.

How do I keep my credit score going up?

There are a few points to keep in mind to keep your credit score at the top.

1. Strategize your credit card payments: Staying within the credit limit above 30% is always good. Credit utilization is the second important factor determining your credit score, and if you want your credit score to rise, pay the balance before the card reports your balance to the credit bureaus. Make your payment on time. The lower utilization of credit is used to calculate your credit score. If you want a good credit score, keep your credit utilization score in single digits.

2. Ensure accuracy and improve credit: If you often get stuck on how to improve your credit score, first review your credit report. It will help you to analyze your strengths and weaknesses. If you find that your payment history is responsible for your low credit score, try to improve this area. It is also good to check your credit score regularly with authorized institutions like your bank.

3. Minimise new credit requests and hard inquiries: Hard inquiries such as applications for a new credit card, a mortgage, or other credit. It is a sign of desperation for new credit. Banks could even think you need money because you are financially unstable. Removing hard inquiries from the report can boost the credit score to a point, but it will make a small difference. If you want to increase your credit score, stop applying for new credit for some time.

4. Rectify inaccurate credit reports: If you find that a certain issue in your credit report is significantly impacting your credit report, you better remove the issue. You can challenge the old information and remove it from your report.

5. Never dispose of your old accounts: Your credit age matters to lenders. If you have an old credit account that you no longer use, keep it safe. It is significant as the credit history of that account will still reflect on your credit report. It will also reflect unavailable credit and increase your credit utilization ratio.

Does your credit score go up every time you pay?

Paying your debts on time indicates your efficiency in managing finances, and if you pay your credit in full, it will help you increase your credit score. Paying a monthly credit card balance won't increase the credit score alone, but it is one factor responsible for a good credit score.

Why is my credit score going down when I pay on time?

Even if you pay your bills on time and your credit score drops, you might have a high credit utilization. It is advisable to maintain at least a 30% credit utilization ratio.

If your credit score drops constantly, even if you pay on time, it can also mean that someone else's activity is reported as yours. Check your credit report  Immediately to see if anyone is using your credit card or applying for a new one.

Check whether you have all your old accounts in a safe place. Closing your old accounts will also automatically increase the utilization ratio and impact your credit score.

What can ruin your credit score?

1. Unpaid debts: Small yet important: If you regularly pay off your loans or other important debts and miss the small ones irrelevant to you, it badly impacts your credit score.

2. Inefficient management of utility bills: We often need to remember to pay our utility bills, like electricity. Though they are not loans, companies don't report the payment history. But if it is your habit, they won't take the time to turn on you, which will seriously impact your credit score.

3. Shopping using a loan: Credit cards are often used for shopping. However, if you use the loan amount to shop for longer, you can lower your credit score.

4. Records not recorded: Sometimes, the records of your positive payment may not be recorded with the credit bureaus. This lack of information may lower your score even if your payments are timely and consistent. 

Final words

A credit score is a number that shows the creditworthiness of a person. It significantly impacts the financial life of a person. It ensures the availability of credit for a person. It means a person with a good credit score will likely get a loan, even at an affordable rate. There are numerous factors that determine the credit score, like timely payment of bills, credit utilization ratio, etc. A credit score of 700 and above is considered good, and lenders look for the same or above to analyze the financial management capability of a person. To maintain a good credit score, it is good to follow those practices that can lower the score, like avoiding applying for new credit and making timely payments on your bills.

Read Also:

1. Capital Adequacy Ratio

2. What is debt?

3. Mutual Funds and Types

4. What If You Pay Minimum Payment on Credit Card