Credit score. This term has been nothing less than a revolution in the Indian financial sector over the past decade. You may have come across tons of information and advice regarding the importance and role of credit scores in our financial life. Even more, if you have taken out or applied for a loan or a credit card. But in the midst of the wave of information we are dumped when it comes to credit score advice, one aspect less covered is how the credit bureaus actually calculate your credit score.
And with the new year 2022 knocking on our door, isn’t this the right time to understand this crucial aspect of your financial life? After all, a credit score has the potential to make or break your chances of loan and credit card approval.
So read on as we help clarify the concept of credit score and simplify how credit bureaus calculate your credit score.
What is a credit score?
A credit score is a three-digit numerical representation of your credit history and typically ranges from 300 to 900. It shows how well you have handled your debt repayments based on your past repayment behavior towards it. of your loan IMEs and credit card invoices.
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How do the credit bureaus calculate your credit score?
Your credit score is calculated by the credit bureaus based on the information included in your credit report, which contains a summary of your current outstanding loans, past credit accounts and existing credit card balances, as well as other credit-related information.
At present there are 4 credit bureaus in India – CIBIL, Equifax, Experian and Crif Highmark. While each of these four credit bureaus has its own scoring parameters and mechanism for calculating the credit score and assigning a weight to the parameters involved, the key factors considered by the bureaus include the repayment history of loans and debts. credit cards, the composition of credit, the rate of use of credit. , age of credit history and credit applications.
Let’s dig deeper and understand these factors.
1. Repayment history of credit card bills and loan IMEs
It is widely accepted that the repayment of your credit card bills and EMI loans is factored in by agencies when calculating your credit score.. Paying off your credit card bills and loan IMEs in full and on time helps build a favorable credit history, which gradually builds up to a strong credit score.
While on the other hand, any irregularity in the repayments of credit cards and loans is likely to damage your credit score, as such actions portray you as financially undisciplined.
In addition, loan accounts co-signed / guaranteed by you are also included in your credit report for credit score calculation as the co-signature / guarantee also makes you responsible for timely repayment of this loan. So when the primary borrower delays or defaults, your credit rating will also be affected, as well as that of the primary borrower. That is why it is advisable to regularly review the repayment activities of your co-signed or guaranteed loan accounts and ensure timely payments to prevent your credit score and future credit eligibility from being compromised.
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2. Credit mixing
The credit mix is the ratio of your unsecured debt (like personal loans and credit cards) to secured debt (like home loans and auto loans). Since lenders generally prefer to lend to those who have a balanced credit mix of secured and unsecured loans in their portfolio, credit bureaus also tend to give these borrowers a higher and more favorable rating. While those who have too many unsecured loans can be viewed negatively by the credit bureau and lenders, which can also adversely affect the credit rating.
3. Credit utilization rate
This ratio is the proportion of your total credit card limit that you are using. For example, if you have a total credit limit of 1.5 lakh and your current credit card contributions are 7500.0, your CUR is 50%. Note that lenders generally view a credit utilization rate of over 30% as a sign of thirst for credit, which can be viewed as a higher likelihood of future credit default. Therefore, the credit bureaus also tend to reduce your credit rating by a few points for going over the 30% mark, which can cause significant damage to your credit rating, especially if done frequently.
4. Credit inquiries
Each time you submit a loan or credit card application, the lender retrieves your credit report from the credit bureaus to assess your creditworthiness and past repayment behavior. Such lender initiated credit report requests are listed as credit inquiries on your credit report, each of which may lower your credit score by a few points. And if you end up submitting multiple credit applications to lenders, especially in a short period of time, your credit score may drop.
So, it is best to spread your requests over different time periods to avoid bombarding lenders with too many requests, and also try to research the eligibility and offers from various lenders and then focus on submitting requests to the most potential ones. uniquely.
5. Age of credit history
Another factor often taken into consideration by credit bureaus when calculating your credit score is the age / length of your credit history. Generally, the longer your credit history, the better your credit score, as lenders and bureaus have a longer view of your credit repayment history. Credit bureaus generally tend to take into account the age of your oldest form of credit, whether it’s a loan or a credit card. For example, you took out your first loan or credit card 5 years ago, so the age of your credit history would be 5 years.
Also Read: Why Your Credit Score Can Drop Despite Making Timely Payments!
How Can You Check Your Credit Score?
There are two ways to check your credit score. You can either retrieve your credit report directly from the credit bureau website or download it from online financial institutions and / or portals / apps that offer the option to download your credit report for free.
Since the credit bureaus are mandated to provide a free credit report to customers at least once a year, you should ideally spread your credit report requests so that you can retrieve a free report every quarter of the year, starting from of the 4 offices available.
Alternatively, some online financial marketplaces also offer the option of getting free credit scores as well as monthly credit reports.
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How Does Your Credit Score Affect Your Chances Of Loan And Credit Card Approval?
A credit score is used as one of the first filters to be considered by lenders when evaluating your loan and credit card applications. It helps the lender, be it a bank, NBFC, or fintech, assess your creditworthiness through past repayment behavior, which also indicates how likely you are to repay. not the loan / credit card in the future.
A good credit score will describe you as more trustworthy, whereas a poor or no credit score (no credit history, which implies that you haven’t taken out a credit card or loan yet) would require the lender to take a cautious approach when deciding whether to accept or reject your application.
In addition to all this, the role of the credit score has gradually expanded to also become the basis for lenders to set the interest rates on your loans, under risk-based pricing. In this practice, those with a higher credit score are likely to get a cheaper loan compared to someone with a low or no credit score.
Is your loan or credit card application rejected with a low or no credit score?
Although financial institutions generally tend to prefer loans to applicants with a credit score of 750 and above, having a low or no credit rating is not always a dead end.because they might be offered loans at relatively higher interest rates than those offered to applicants with high credit scores. This higher interest rate is charged to cover the presence of higher credit risk, i.e. risk of default, among those with low or no credit rating. However, the final decision is up to the lender after considering not only the credit rating but other aspects like income, loan amount, age, existing debts, etc.
Also read: 5 super financial resolutions for the new year 2022
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