We dive into the origins of credit scores, how they’re calculated, and most importantly, how you can boost yours. Whether you’re aiming to buy your first home, snag that dream car, or just want to feel more secure in your financial choices, getting a grip on your credit score is a vital step. So, let’s break it down together and empower you to take charge of your financial future!
Table Of Contents
· Introduction
· The 2008 Recession: A Case Study in Bad Debt
· What Is a Credit Score?
· Origins of Credit Scores
· How Is a Credit Score Calculated?
· Illustrating Credit Scores with an Example
· Credit Score Ranges: From Bad to Good
· How to Improve Your Credit Score?
· Conclusion
· References
Introduction
In my previous article, I explored the concept of credit and its evolution.
It discussed the idea of credit, how it evolved, future trends, and most importantly, why borrowers should use credit cautiously.
On paper, borrowing money and repaying it in small installments sounds like a dream come true!
Imagine living in your dream house before even paying the full amount!
However, there’s a catch!
Not everyone is willing to lend you money.
Ask yourself this question:
If a friend or relative asked you for a significant amount, wouldn’t you hesitate before handing over the money?
Of course! You’d think twice because there’s no guarantee you’ll get your money back.
Now, imagine the same situation on a much larger scale!
A global bank or financial institution faces major disruptions if clients fail to repay their loans (also known as bad debts).
If bad debts continue to accumulate, the financial institution risks collapse. One of the most well-known examples of this is the 2008 U.S. Recession.
The 2008 Recession: A Case Study in Bad Debt
A real-life example of bad debts leading to disaster was the 2008 financial crisis.
Numerous banks issued home loans without properly assessing the borrower’s creditworthiness.
As defaults piled up, the situation spiraled out of control, severely impacting banking operations and forcing government intervention.
If you want to learn more about this crisis, I highly recommend watching The Big Short. This film cleverly combines comedy and drama to explain the events leading up to the U.S. recession.
What Is a Credit Score?
No one can predict the future.
Likewise, banks can’t determine with certainty if a customer will repay their loan.
A key factor that all lenders (banks, NBFCs, or even individuals) consider before lending money is trust.
But how can a lender assess a borrower’s trustworthiness?
The answer lies in Credit Scores.
A credit score is a three-digit number that measures a borrower’s likelihood of repaying loans on time.
Credit Score Range:
The score typically ranges between 300 and 850.
Think of it like XP (Experience Points) in a video game.
- As a player, you start at the bottom (300).
- With each successful payment, you gain points.
- Once you surpass 700, you reach an upgraded level — indicating that you are a highly trustworthy borrower!
Origins of Credit Scores
During the 19th century, the concept of consumer lending was unheard of. Most financial institutions did not trust consumers.
The most well-known credit reporting agencies at the time were:
- Bradstreet Company
- R.G. Dun & Co.
These agencies collected borrower data manually.
In the early 20th century, some retail and grocery stores introduced the concept of consumer credit.
However, the credit-scoring system at the time was basic and lacked accuracy.
Enter FICO: The Game Changer
The turning point came in 1956 when William Fair and Earl Isaac founded Fair Isaac Corporation (FICO).
FICO introduced an objective scoring system that used quantitative factors to assess creditworthiness.
Within a few years, over 50 American lending companies adopted this system.
Eventually, banks and financial institutions worldwide started using credit scores to assess borrowers more effectively.
Global Credit Agencies
Several agencies now track credit information:
- Equifax (USA)
- Experian (USA)
- Highmark (USA)
- CIBIL (India) — Licensed by RBI (Reserve Bank of India).
How Is a Credit Score Calculated?
While each credit bureau has its own scoring model, most use these five key factors:
1️⃣ Payment History
- Have you made on-time payments?
- How many times have you been late?
2️⃣ Credit Utilization
- What percentage of your available credit are you using?
- Lower utilization = Better score.
3️⃣ Credit History Length
- How long have you been borrowing money?
- Longer credit history = Lower risk for lenders.
4️⃣ Credit Mix
- Do you have a mix of different types of credit? (e.g., loans, credit cards, BNPL services)
- A diverse mix signals good credit management.
5️⃣ New Credit Applications
- Are you applying for too many credit lines?
- Frequent applications signal desperation and lower your score.
Illustrating Credit Scores with an Example
Let’s consider a fictional character:
Aditya, a 27-year-old IT professional from New Delhi.
Aditya’s Credit Profile:
- Owns two credit cards
- Uses ‘LazyPay‘ (Buy Now, Pay Later app)
- Purchased an ‘Ather’ 450 electric scooter on loan
Breakdown of His Payments:
- Scooter Loan: ₹1,65,000 (EMI: ₹10,000/month)
- Axis Bank Credit Card: ₹1,500 EMI (Credit Limit: ₹3,00,000)
- SBI Credit Card: ₹2,000 EMI (Credit Limit: ₹2,00,000)
- ‘LazyPay’ Dues: ₹459/month (Credit Limit: ₹4,000)
Why Does Aditya Have a Good Credit Score?
✔ He makes all payments on time.
✔ He maintains a good credit mix (loans, credit cards, BNPL).
✔ He uses only a small portion of his available credit limit.
✔ He hasn’t applied for multiple credit cards recently.
Credit Score Ranges: From Bad to Good
Credit scores range from 300 to 850.
Here’s what different scores mean:
How to Improve Your Credit Score?
Now that we understand credit scores and their calculation, here are some tips to improve yours:
✅ Make Timely Payments — Pay your EMIs and credit card bills on time. Six months of consistent payments can significantly boost your score.
✅ Increase Your Credit Limit — If you have a good repayment history, banks may increase your credit limit. But spend cautiously!
✅ Limit New Credit Applications — Avoid applying for too many credit cards in a short period. Lenders might view you as a high-risk borrower.
Conclusion
Whether in personal relationships, professional work, or finance, trust is crucial.
A strong credit score builds financial trust. It determines how easily you can access credit in the future.
Hopefully, this article has given you a clear understanding of credit scores.
If you’d like to check your credit score, visit these websites:
CIBIL: https://www.cibil.com/freecibilscore
CRED: https://cred.club/check-your-credit-score
Paisabazaar: https://www.paisabazaar.com/cibil-credit-report/
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