Disciplined use of your credit accounts, clearing all your dues on time and maintaining a good credit utilization ratio helps you build a good credit score. While credit bureaus give the highest weightage to payment history and CUR, some other factors also play an important role in building your credit score.
One such factor is the length of your credit history, which largely depends on the average age of your credit accounts. Though it may not be the most important scoring factor, a long history of managing different credit accounts efficiently will always work in favour of your credit score.
How Do Credit Bureaus Calculate the Length of Your Credit History?
You can download your free credit report from Paisabazaar.com and check the summary of all your credit accounts where you can also see the date on which you opened each account. Why is this date important?
As per Experian, credit bureaus may use three different metrics when calculating the age of your credit accounts, including:
- Age of your oldest account
- Duration since you have opened an account
- Average age of all your accounts
This is why the date of opening your credit account is an important piece of information for credit bureaus. A longer credit history is better for your credit score.
However, a shorter age of your credit accounts does not necessarily mean that your credit score will be lower in comparison to someone with a longer history. This is because the length of your credit history matters but other factors like timely payment and utilization ratio make up for it, during the initial stages of your credit journey.
To make your credit history work in favour of your credit score, all you can do all your credit accounts in good standing. You should also avoid closing your older credit accounts.
What Happens When You Close a Credit Card?
Many financial experts caution against closing your credit cards, especially your oldest credit cards. However, the reason how it negatively affects your credit score is often misunderstood.
When you close a credit card, the age of your credit history does not drop suddenly. In fact, positive accounts may stay on your profile for 10 years whereas accounts closed out of delinquencies stay for 7 years. However, this may also vary for different credit bureaus.
When you close a positive credit card account, the overall credit limit available to you suddenly decreases. This may result in a sharp spike in your credit utilization ratio (CUR), which, in turn, reduces your credit score.
If you no longer use a credit card and do not want to pay the annual fee, you can look for other ways to stop using that account, instead of closing it. For example, you can ask your card issuer to switch to another credit card, which is more suited to your needs. If you do not find any card from the issuer that matches your spending preferences, you may choose a lifetime-free card from the issuer’s offerings.
What Can You Do to Improve the Length of Your Credit History?
In practical sense, you cannot really do anything about improving the length of your credit history. It only requires patience, continued disciplined use of your credit cards and timely payment of your loan EMIs.
If you are new to credit, you may start building your credit history by opening a credit account such as a credit card. It is easier to get approved for an entry-level credit card as they come with easier eligibility terms and require low income. If you are not eligible for regular unsecured credit cards, you can also opt for a secured credit card, which is offered against a collateral, usually fixed deposit.
An important point to note here is that having too many credit accounts may lower the average age of your credit. Since the latter is also an important factor, you should be cautious in applying for new loans for discretionary expenses or taking credit cards that you think you might not use in future
What Are the Other Factors That Affect Your Credit Score?
Though the weightage percentages may differ across credit bureaus, each bureau gives the highest weightage to payment history. This includes information about whether you have made on-time payments, missed due dates, etc.
This is followed by the credit utilization ratio (CUR), which is the ratio of the credit you are using to the total credit limit available with you. Keeping an extremely high CUR or exhausting your credit limit every month may lead to a reduced credit score.
Payment history and CUR are the two factors that together make up more than 50% of your credit score. Apart from these, credit mix, length of credit history and new enquiries are also taken into consideration.
While the age of your credit history is important, it does not mean that you cannot have an excellent credit score with a short history. Timely payments and disciplined usage make up for it.
To build a good credit score, you should focus on the most important categories:
- Make all your monthly payments on time
- Do not exhaust the entire credit limit on your credit cards
- Do not apply for too many new accounts within a short span
Over time, all of these actions will help you build an excellent credit score. As your credit age increases, it will add to the positive points as it shows that you are able to manage multiple credit accounts for a long time.