Personal financial management is a key concept that is unfortunately not emphasised enough in our society. Personal financial management teaches the key skills for saving, spending and investment to individuals. Since these skills are not emphasised enough from a young age, we see individuals indulging in poor financial habits that end up putting them under debt or worse these habits end up destroying their credit scores.

So what exactly is a credit score and why are they so important to be maintained?

A credit score is a figure that indicates the credit worthiness of an individual. From the time an individual turns legally adult and they start to pay their bills, take out loans or use a credit card. Their credit report records every bit down.

Credit report is a report that comprises the credit history of an individual. It includes how many loans the individual has taken, how many are current and how many have been paid off. Whether the individual pays the loan and utility bills on time or not and whether there are any bankruptcies, delinquencies or court orders against the individuals in their past?

Credit reports are compiled mainly by the three big credit reporting bureaus in America. Credit scores are calculated on the basis of the credit report maintained by the three bureaus. A credit score distills down the credit worthiness of an individual down to a three digit number.

The credit score can be graded, so as to say in the following tiers.

• Excellent: 800 to 850
• Very Good: 740 to 799
• Good: 670 to 739
• Fair: 580 to 669
• Poor: 300 to 579

Preferably one should aim to keep their credit score above 650 at all times. These credit scores are, as mentioned above, composed of the credit report of an individual. Credit scores falling in the good range and above are considered safe and less risky for lenders and therefore individuals having these credit scores can expect to get favorable terms and rates when applying for loans and credit based financial products.

The specific areas from which the credit scores are composed are as follows.

• Payment history – 35%
• Total amount owed – 30%
• Length of credit history – 15%
• Types of credit – 10%
• New credit – 10%

The breakdown of the percentages mentioned above is as follows.

Payment History – 35%

Payment history makes up over one third of the credit report. This includes the payments that were made on time or after time. Needless to say that as long as an individual makes payments on time, their credit report gets marked positively. Any missed or overdue payments will register as negative on the credit report.

Timely payment of all loans and utility bills can therefore have a one third impact on the credit score.

Amount Owed – 30%

Outstanding dues make up to 30% of the credit report. The less a person owes to creditors the better it will be for the credit score. This is why it is advised to keep the credit utilisation on credit cards below 30% as a higher rate of credit utilization will push up this number and register negatively on the credit report.

It can be seen that timely payments have quite a significant impact on the credit report. Similarly timely payments combined with the total debt owed make up 65% of the credit score. Therefore by keeping the loans to a minimum and making timely payments, one can quite easily take care of almost 65% of the credit score.

Length of credit history – 15%

Length of credit history is a factor that develops over time, the only thing one can do is to keep the accounts and credit cards active and let them accumulate history. If you have got credit cards that you do not use, then do not get them closed as it will not be of much help for your credit score. Instead keeping old cards active will register positively on your card and will help in establishing your credit history.

Credit mix – Types of credit and New Credit – 20%

Types of credit make up only 10%. Lenders look at the type of debt that the individual has taken out over the past. Unsecured debt is seen positively because it shows that other lenders have a high degree of trust on the individual, secured debts show that the individual is prudent and perhaps not doing so well financially. Ideally one should have a diverse credit mix including credit cards, mortgage, different bank accounts and so on. The more diverse the credit mix is, the better it will be for the credit score. However be careful not to take on unnecessary loans just to diversify your credit mix.

Impact of Instalment loans on credit?

In light of what has been discussed, the impact of installment loans on credit can vary. Firstly, whatever the term limit of the instalment loan is, it should be repaid on time. As long as the borrower makes timely payments, it will have a positive impact and will result in an improvement in the credit score.

The impact also depends on the debt already owed. If the borrower does not have any existing debt or very low debt then taking on a new loan will have a minimum negative impact but timely payments will make up for it over time.

If however the borrower already has a lot of debts then the additional instalment debt may end up making the credit score worse.

One most important factor is the reporting criteria of the lender. If the lender reports to any of the three credit bureaus, then yes the instalment loan will impact your credit score for better or for worse but however if the lender does not report to any bureau then it will not have any impact on your credit score. What this means is that even though any late payments will not negatively impact your score but timely payments too will not have any positive impact as nothing is being reported to the credit reporting bureaus.