What is a credit score?
A credit score is a number that stands a person's creditworthiness. This is a statistically compiled numeric value that lenders widely use to ascertain how likely a person taking a loan will pay it back. The common inference being that if a person has behaved responsibly to pay back his loans in the past, he will continue to do so in the future.
Past behaviour in paying back loans is called credit history and a person’s creditworthiness is built around that. In India, Credit rating and Information Bureau of India Ltd. (CIBIL) is the statutory body that maintains a database of credit standings of individuals and commercial entities.
In India the credit score for an individual ranges between 300-900. A good CIBIL score is considered to be 750+ in India. The higher it is, the higher a borrower’s credit standing.
How credit scores go bad
So much of credit related data is shrouded in misinformation and secrecy and people are often not advised to use their credit sources responsibly. So people might have acted in ignorance but end up with a bad credit score.
There are several factors that affect credit scores and their importance varies. But there is general agreement on factors that go into developing credit scores.
Improper credit utilization: Credit utilization is simply the ratio between how much credit you are sanctioned and what percentage of it you are using. This means what is the upper limit of all your credit cards and where you stand in terms of their usage. If you use a very high percentage of your limit, your credit score may turn bad.
History of past repayment: The first and foremost thing that a lender looks for is your past behavior in repaying debt. If you have paid all your debts in full and in time, your credit standing is good. But if you have defaulted or your payments are irregular, it will have a negative impact on your credit score.
Length of debt-servicing: How long you have been availing credit and servicing it is also a determinant in your credit score. New applicants for credit usually have a low credit score than people who are already using credit for a while.
The right mix of credit: Credit rating agencies also look at what types of credit and whether you have got the right mix. Availing multiple sources of credit like credit cards, personal loans and secured loans is a better idea than relying on any source excessively.
New credit applications: The frequency at which you have applied for a new credit also has a bearing on your credit score. Lenders can actually see how many times you have applied and how many times you have been approved/rejected so applying way too many times can reflect badly.
Top 5 credit score improvement factors
As a borrower, you can maintain a responsible and punctual approach towards paying your loans that in the long-run can improve your credit score. Here are top 5 steps you can take to achieve this:
- Check your credit score before applying: Since CIBIL lets consumers get credit scores directly and instantly on their website, you can always check your score before applying for a fresh loan or credit card. By paying only Rs. 470, you can get it electronically or by post. This helps in two ways—you can be sure that there are no negative factors on your credit score and confidently apply and since lenders can also see which other lender has rejected your application, restrain from going ahead if your score is not in the desired range.
- Be punctual in your credit card payments: Do not default on your credit card or loan payments as it can create a negative shadow on your creditworthiness. You can fall back on your friends and relatives for short-term loans just to meet these deadlines of credit card payments or loan instalments.
- If you do not have credit history, create one: Some first-timers may not have a credit history to for lenders to go on. For them the credit score is zero or zilch and that’s why banks and financial institutions may hesitate to sanction them a loan. But they can get around this problem by opening a fixed deposit and then taking a credit card against it. By making regular payments on this credit card, they can improve their credit score.
- Spread usage across different card limits: If you have several credit cards but use only one to spend extensively, your credit score can be adversely affected. It is wiser to spread your expenditure over several credit cards instead of using a larger percentage on a single card.
- Do not raise disputes unnecessarily: If it is a case of undue charges, fraudulent transactions or interest rates that crops up on your credit card statements, contact the customer care department of your credit card issuer. But if you’ve made a late payment and are charged penal interest, do not unnecessarily raise disputes. If you do so, credit card companies may freeze your card and that can affect your credit score.
How does CIBIL keep track of your credit score?
When you spend on your credit card or make a loan repayment, your bank keeps a record of it. The bank or financial institution shares these records with CIBIL on a monthly basis. This goes to generate your Credit Information Report (CIR) or score which other lenders can use to determine your creditworthiness. Thus, CIBIL is the definitive agency to help assess risk profiles of borrowers. It lends a degree of safety to banks and financial institutions in its lending processes.
How do lenders use credit scores?
In the loan approval process, the TransUnion Score and the Credit Information Report (CIR)—both generated by CIBIL—play a crucial role. This information is available online and lenders can directly access these data points to see if the loan applicant qualifies. The score essentially is a glance at an individual’s credit history, his/her current loan commitments and repayment ability. After these checks, lenders may ask borrowers for documents like identity proof, address proof and proof of income so that the loan may finally be sanctioned.