How is Credit Score Calculated: Debunking Common Myths and Facts

Credit scores have become a central part of our financial lives. From loan approvals to interest rates, this three-digit number carries more influence than most people realize. Yet for something so important, credit scores remain widely misunderstood.

Many people often ask how a credit score is calculated, assuming there's a complex formula behind it. In reality, it follows a straightforward structure, with just a few critical factors influencing your number. By understanding these, you can take control of your credit health, avoid unnecessary pitfalls, and build a stronger financial future.

Let’s begin with the basics before we bust the biggest myths around credit scores.

What is a Credit Score?

A credit score is a numeric summary of your creditworthiness, typically ranging between 300 and 900. It is based on your credit history, repayment habits, and usage patterns. Banks, NBFCs, and even some employers use it to assess financial reliability. A high score usually means better access to credit and lower interest rates.

While there are different credit bureaus, the general structure of how credit scores are calculated remains similar across the board. Understanding this structure is key to improving your financial profile.

Key Factors That Determine Your Credit Score

Here are the core components that go into calculating a credit score:

1. Payment History

Whether you pay your bills on time plays the most crucial role. Missed or late payments can significantly reduce your score.

2. Credit Utilization

This measures how much of your available credit you're using. Ideally, usage should stay under 30%.

3. Length of Credit History

The longer your credit accounts have been active, the better. Lenders prefer a stable, long-standing credit history.

4. Credit Mix

A diverse mix of credit, credit cards, personal loans, and EMIs can positively impact your score.

5. New Credit Inquiries

Too many recent loan or credit card applications can harm your score, as they signal financial pressure.

Understanding these elements helps clarify how credit scores are calculated and offers a clear path to managing them.

Common Myths vs. Facts About Credit Scores

Misconceptions about credit scores can lead to poor financial decisions. Let’s clear up the most common myths with facts that actually reflect how credit scores function.

Myth 1: Checking your score lowers it

Fact: A credit score check done by you is considered a soft inquiry and has no impact on your score. In fact, checking regularly helps you catch errors or identity fraud early.

Myth 2: High income means a high score

Fact: Your salary isn’t a part of the credit score formula. What matters is whether you repay borrowed money responsibly and manage your credit well.

Myth 3: No loans mean excellent credit

Fact: If you’ve never used any form of credit, there’s nothing for the credit bureau to evaluate. No history means no score, which can be as limiting as a low score.

Myth 4: Settling a loan helps your score

Fact: A “settled” status often means you paid less than what was originally agreed. This is considered a negative factor by lenders and can lower your credit score.

Myth 5: Closing old credit cards improves your score

Fact: Closing your oldest card can shorten your credit history and affect your credit utilization ratio. Keeping old accounts open and in good standing is better for your score.

Myth 6: A single late payment won’t matter

Fact: Even one missed payment can reduce your score, especially if your history was otherwise spotless. The effect may be less for older, well-maintained credit profiles, but the risk isn’t worth it.

Myth 7: You need to carry a balance to improve your score

Fact: You don’t have to carry unpaid balances or pay interest to boost your score. Paying your bills in full every month is both financially wise and good for your credit health.

Myth 8: All credit bureaus have the same score

Fact: India has four main credit bureaus: TransUnion CIBIL, CRIF High Mark, Experian, and Equifax, each using its own model. Scores may differ slightly across them. It's helpful to check your credit score periodically across different platforms.

Myth 9: Loan approvals only depend on credit score

Fact: While your credit score is crucial, lenders also look at other details like income, employment stability, and existing obligations before approving a loan or card.

Myth 10: Once damaged, your score can’t be fixed

Fact: Credit scores are dynamic. With disciplined repayment, reduced debt, and fewer new applications, most credit issues can be corrected over time.

Understanding these facts helps you build habits aligned with how credit score is calculated, rather than reacting to incorrect assumptions.

Ready to Take Charge of Your Credit Journey?

A strong credit score isn’t just about borrowing; it’s about being seen as financially responsible. The more you understand how credit scores are calculated, the more empowered you become to shape your financial future. Don’t let myths cloud your decisions. Stick to facts, monitor your score, and adopt healthy financial habits.

And when you’re ready to start keeping track of your credit health, platforms like Olyv can help you with a free, secure credit score check. This way, you’re always a step ahead, whether you’re applying for a loan, buying a car, or planning your next big move.