Have you ever wondered why banks say yes to one person’s loan application and shake their heads at another? Well, one of the key ingredients in this mystery is a credit score!
When you hear loan approval, credit cards, or anything else related to borrowing money, do you have any idea what a credit score or CIBIL score is? Why is it that banks and financial institutions take it seriously before approving a loan? And most importantly, what does it have to do with you?
Don’t worry; there’s nothing to lose in understanding what your credit score says about your financial life, even if you are not planning to take a personal loan or a car loan. But to start with, here’s a little guide on the credit profile and why it is important
CREDIT SCORE
A credit score is a 3-digit number that shows your ability to pay back a loan based on the borrower’s credit history. In layman’s terms, a credit score is your financial reputation. Say, for instance, one friend pays all their dues on time while another friend is often late with payments, the friend who rarely misses a due date gets a better credit score at the end of the year! The credit score evaluates the borrower’s reliability in repaying a loan. However, to add that the credit score evaluates only a part of this financial health, and it does not get a complete picture, your credit score alone can not predict the future.
There could be some people with a good credit score who earn as much as they want, and there are some who earn a decent income but still have a low credit score.
CIBIL SCORE
CIBIL stands for Credit Information Bureau (India) Limited, and as per information on the TransUnion CIBIL website, TransUnion CIBIL is one of the credit information companies in India. That means credit information companies like TransUnion CIBIL collect credit information for banks and other financial institutions about your repayment performance on loans and credit cards and calculate what is known as a CIBIL Score.
So, your CIBIL score is a numeric summary of your credit history. As a rough guide, a higher score means you are a better borrower. Also, the term ‘credit score’ is often used interchangeably with the term ‘CIBIL score.’ However, that is only partly correct since CIBIL is just one of the credit information companies that calculate credit scores. On the flip side, your credit report is much more than just your ‘score.’
This report usually contains the total loans and credit cards issued to you, your payment history, and other relevant information regarding your credit. Now that we have understood what a credit score is, let us understand Why it is important.
WHY IS CREDIT SCORE IMPORTANT
A credit score is important since it helps lenders to decide if you are a good candidate to grant a loan or not.
When you apply for a home loan or a personal loan or even a credit card, the bank takes a look at your credit score and determines whether you can repay the money you are about to get.
So, a high credit score indicates to the lender that the possibility of the applicant defaulting on payments is low.
To add to that, the credit score also helps the financial institutions to decide the rate of interest that the borrower will have to pay. For example, a high credit score usually means the borrower has to repay a lower rate of interest compared to someone with a low credit score. Therefore, the credit score is your gateway to loan approval – but only the right credit score!
Let us next understand what a good credit score in India is.
GOOD CREDIT SCORE IN INDIA
For transction CIBIL, credit scores range between 300-900. However, this is entirely subjective to the bank or the financial institution. As a general rule of thumb, the higher the score, the better! Now, 750 and above is considered a good credit score in most cases. But again, each bank has its rules and regulations for giving out loans.
You can generally understand the categorization of credit scores
Credit score General interpretation
- 300 – 549 Low credit score range
- 550 – 649 Fair credit score range
- 650 – 749 Good credit score range
- 750 – 900 Ideal credit score range
The above is entirely subjective to the lending institution. So, when you see a credit score, do not be alarmed if it does not fit any of the categories above. After all, it is the banks’ choice whether to give you the loan or not. So, even if the score was 750, you might still not get the loan approval. On the other hand, if your credit score was lower than 750, you still might get the loan approval.
DOES A CREDIT SCORE AFFECT YOUR LOAN APPROVAL
Let’s suppose there are two friends, Priya and Divya. Both apply for a personal loan, but since Priya has been paying her debts and her credit card bill on time, her credit score is high. Divya, on the other hand, often misses payments and has a high credit card balance. She ends up with a low credit score. So, when the banks take a look at both the girls’ credit scores, they might be inclined to approve Priya’s loan whereas Divya’s loan application gets rejected.
That is not to say that Priya’s loan application gets automatically approved. Or that Divya’s loan application gets automatically rejected. Both the loan applications would have to meet certain specific criteria set by the banks and personal loan companies. Since she has a good credit score, the bank may be able to see that Priya has a good repayment source whereas Divya does not have any proof of repayment. Also, while Divya’s income might have been lower than Priya’s – it still can be enough to repay the loan. Now, this example is a hypothetical case, but it brings about an important point. The higher the credit score, the more chances are that your loan gets approved!
Moving on, the following points summarize why a credit score is so important.
FACTORS AFFECT YOUR CREDIT SCORE
Payment history: Since banks keep a record of what a particular person’s repayment history has been like, it becomes a very crucial factor in calculating credit scores. If someone has never defaulted on their payments or only defaulted a couple of times – they stand to have a good credit history. Whereas someone who has frequently defaulted on their payments would have a low credit score.
Credit Utilization: Credit Utilization is the ratio of the balance on one’s credit card and the total credit limit one holds. Credit utilization is calculated as (Amount utilized/Accrued credit limit)100. So, someone with a credit card of Rs. 1, 00, 000 and with a balance of Rs. 40, 000 on their credit card would have a credit utilization of 40%. This person would then, on an average, have a better credit score as compared to a person with a higher credit utilization.
Length of credit: Having a long credit history will have a small impact on your credit score. Whereas having a short credit history shows the lenders that you are a new borrower. To add to that, it is not always advised to take loans or credit cards just to build up your credit history. One should only take up credit if they can repay it.
Credit Application: Applying for multiple credit cards at the same time can reduce your score. It shows the lender that you might be in more debt than you can repay. So, always apply for a loan if you need it.
Credit Mix: Your credit mix is comprised of the different kinds of credit you use – secured and unsecured loan. So, a healthy mix of all types of credit is very essential for you to maintain a good credit score. Again, people should not borrow more than they have to in order to build their credit mix. All things considered, it is a person’s repayment capacity that matters more than their credit score.
Now that we know a little more about what affects your credit score, let us move onto the topic: increasing your credit score!
HOW CAN YOU IMPROVE YOUR CREDIT SCORE
Keeping your credit card balance low: Maintaining a balance that exceeds 30% on your credit cards lowers your credit score. So, one must always spend within one’s means to avoid increasing their credit score. It is always advised to keep a record of all the expenses that one makes so that they do not spend more than they intend to.
Avoid applying for credit unnecessarily: Applying for credit cards or multiple personal loans in one go not only burdens you with debt, but also lowers your credit score. Always go for personal loans and credit cards only when you really need them, and then, compare the best offers on the web.
Checking the credit report: It is always a good idea to keep track of all the dues one incurs and make sure that all their details are correct. If there is an error and one finds incorrect information about the credit score or report, one needs to immediately inform the credit bureau so that the necessary corrections are put in place.
Borrow only what you need: One should never borrow extra money just to boost their credit since it is only those who are able to repay their loans on time that can obtain a healthy credit score. It is essential that before one applies for any sort of loan, they keep in mind their income and expenditure. A loan that one cannot repay would only add to their burden. Now that we understand how we can boost our credit score, let us next understand the common mistakes that hurt one’s credit score.
COMMON MISTAKES THAT LOWER THE CREDIT SCORE
When it comes to lowering credit scores, there are several common issues which affect one’s credit report. Avoiding them helps maintain a healthy credit score. They are as follows:
Missing payments on your EMIs We all have times in our lives where we are short on cash to pay our taxes or our loan instalment. However, it is always advised to have some extra money stashed away for such occurrences and to avoid missing your payments all together.
Missing credit card payments as well can result in damaging your credit score.
Having a high credit utilization ratio Credit utilization is directly proportional to one’s credit score. Avoid keeping a credit card balance of more than 30% on a regular basis to avoid lowering one’s credit score.
Applying for credit cards or loans unnecessarily Applying for credit cards all at once or applying for personal loans unnecessarily results in multiple accounts being opened at the same time, which negatively impacts your credit score.
Not checking your credit report regularly Checking your credit report allows one to keep track of their credit score and maintain a healthy credit score. It would, therefore be a good idea to keep in touch with your credit report and ensure there are no mistakes in it. Mistakes in credit reports could include displaying outstanding amounts incorrectly and displaying loan accounts incorrectly.
Taking up big loans without considering the repercussions that it would have. Taking up a big loan just to avoid damaging your credit score would only damage the former.
One of the mistakes that people usually take is checking their credit score. Checking your credit score does not lower the score. However, when you apply for a loan, the lender looks at your credit file and this could lower your credit score.
A lot of people worry that checking their credit files lowers their credit score. Checking the credit file does not affect the credit score in any way! Only when the lender checks a credit score does it affect the credit score. Thus, checking one’s credit report has no bearing on lowering the credit score.
CAN YOU STILL GET A LOAN WITH A LOW CREDIT SCORE
Yes! There is hope even for those with low credit scores – banks and personal loan companies just evaluate your application against more criteria, such as your income and existing debt levels, before giving the green signal. Based on your income and existing debts, you may be eligible for a lower loan amount and higher rate of interest.
While there is the option of getting a loan with a low credit score, it does come with disadvantages like you will not get flexible terms and high interest rate. Also, in some instances, depending on the lending institution, the lender may request for a guarantor or any other kind of support (if permissible under its lending policy). So, if you have a low credit score, take care to understand your options.
Next, find out why your credit score suddenly lowered.
CONCLUSION
A credit score plays a huge role in our financial life. These 3-digit numbers summarize our financial performance regarding loans and credit cards. When you learn about credit scores and reports, you learn what they mean, how they are determined, and what you need to do in order to better your credit score! The next time banks ask for your CIBIL score or credit score, you need not feel like you have no idea what they are talking about. After all, understanding your credit scores can help you make smart financial decisions for your future!
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