When you apply for a loan, the first thing your lender looks at is your credit score. If the score is decent, your application may be approved. Credit score has become a crucial parameter for measuring a borrower’s loan eligibility. But what exactly is a credit score, how is it calculated and why is it so important?
Let’s understand the concept of credit score in detail.
Credit score, also known as the CIBIL score, is a 3-digit number that signifies your creditworthiness. In simple words, it shows your ability to repay the borrowed amount and it is calculated based on how timely your past loan repayments have been.
The credit score is calculated by credit information companies. These companies calculate scores based on credit records that are submitted by the lenders. Some of the examples of credit information firms are CIBIL or Credit Information Bureau (India) Limited, Experian and Equifax.
How to read a credit score
The credit score ranges from 300 to 900. A score above 750 is considered an excellent one, while a score between 650 and 750 is deemed average and below 650 is a poor one. This means the higher your score is, the better the chances of you getting a loan.
Importance of a credit score
A credit score is imperative as a good score raises the chances of your loan application being approved. If it is low, the lender may simply discard the application.However, it’s important to note here that credit score is not the only factor considered to check your ability to secure new credit.
Factors that can impact the credit score
A credit score depends on a lot of factors that a credit bureau takes into consideration while calculating your score. Some of the key ones are:
Payment history
This is one of the most crucial factors in determining a person’s score. A good track record of timely repayments is essential for a higher credit score. Missing payments will have a negative impact on your credit score. Hence, you should prioritise payment of your EMIs on time.
Credit utilisation ratio or CUR
The ratio of the credit amount you spend to the credit amount available to you is known as the credit utilisation ratio. It is a vital factor that affects credit scores. It is considered ideal to use under 30-40% of the credit limit available on the card. If the utilisation becomes too high, it may indicate that you survive on credit. This could impact the credit score adversely even if payments are done on time.
Duration of credit history
The duration of credit history also influences the computation of the credit score. The longer the credit line, the stronger it reflects upon your ability to keep paying your dues, which is why closing an old credit line may often reduce the score.
Hard inquiry
When you enquire about credit, the lender will pull out your CIBIL report. This process is called a hard inquiry and it has a bearing on your score. Too many inquiries may affect your score by suggesting that you live on credit just like in the case of CUR above. It is best to avoid applying for multiple loans to lower the number of hard inquiries on the credit report.
Credit mix
If you have taken various types of loans and repaid them responsibly, it shows your ability to handle different kinds of credit.
Some tips to increase your credit score
Make timely payments
Try to make timely and full payment of credit card dues and loan EMIs. It’s important to understand that one late payment could hit the score hard. If you have several EMIs, it is better to set up payment reminders to get more organized.
Avoid taking cash from credit cards
Debiting cash from a credit card can be hard on pockets as lenders charge more interest for it than they do for a purchase. Also, it adversely impacts your score.
Keep reviewing the report
You should check your credit report periodically to understand your credit health and gradually work towards improving it. This will help in finding out if there is any misinformation or error in the report. Any wrong information in the report should be taken up with the credit firm and the lender concerned for rectification.
Avoid making too many credit enquiries
As stated above, making multiple enquiries for credit will affect the CIBIL score. So, it’s better to apply for a credit card or a loan only when it is absolutely necessary.
Benefits of a high credit score
There are several benefits of having a good credit score that include:
Quick loan approvals
A high score means that you have been responsible with your payments. Therefore, lenders may take less time to do a background check.
Higher credit limits
A higher credit score helps you in getting credit cards with a higher credit limit. Since you have displayed good credit behaviour, there are chances that lenders may increase the credit limit on your credit card.
Discount on interest rate
With a high score, you can negotiate and ask the lenders to give a discount on the interest rate for a loan.
Discount on processing fees and other charges
Along with a discount on rates, you can also negotiate for a waiver or discount on fees with a high credit score.
How to check credit score online
The Reserve Bank of India (RBI) has mandated all the credit bureaus to offer one free credit report to consumers per calendar year. For checking your score, you simply need to log on to the official website of any credit bureau and click on ‘Know Your Score’. An online form asking for details such as name, date of birth, address, and ID proof may appear. After filling this, an OTP will be sent to your registered mobile number. Once you are successful verified, you will receive your credit score.
Several financial aggregators and lenders also offer the option of checking credit scores on their platforms. While some may be free, others may be chargeable.
