Digital world has set credit score as your new identity. A credit score is a three-digit number that depicts a consumer’s creditworthiness. The higher the score, the better a borrower looks to potential lenders. The credit score also comes with a report which carries information like number of loan accounts, history of taking loans/credit, repayment track record etc. The potential lenders use credit scores to evaluate the probability that an individual or a firm will repay loans in a timely manner. In other words whether he or she or the firm is worth giving loan/credit.
What is a Credit Score?
As mentioned earlier a credit score is a three-digit number that depicts a consumer’s creditworthiness. The Credit Information Companies (CICs) evaluate five main factors when calculating a credit score:
- Payment history
- Total amount owed
- Length of credit history
- Types of credit
- New credit search
The payment history counts for 35% of a credit score and shows whether a person pays their obligations on time. Total amount owed counts for 30%. It takes into account the percentage of credit being used against the available credit, which is known as credit utilization. The length of credit history counts for 15%. The longer credit histories being considered less risky, as there is more data to determine payment history.
The type of credit used counts for 10%. It refers to a mix of instalment credit, such as car loans or mortgage loans, revolving credit, such as credit cards etc. The new credit also counts for 10%. It factors in how many new accounts a person has and how many new accounts have been applied for recently. This result in credit inquiries also covered under this.
While every creditor defines its own ranges for credit scores, the average score range and its interpretation is below:
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
Generally, a credit score of 700 or above is good. A good score helps the borrower to receive a credit with better terms such as interest rate. A lower interest rate results in paying less money as interest over the life of the loan. A scores greater than 800 is excellent. Your credit score, a statistical analysis of your creditworthiness. It directly affects how much or how little you might pay for any lines of credit you take out.
In case of business firm, the score is in the range of 1 to 10. The higher the rate better it is.
How credit scores work?
In India presently there are 4 CICs who provide credit score of consumers. They are
1) Experian Credit Information Company of India Pvt. Ltd. [Experian],
2) TransUnion Credit Information Bureau of India (TUCIBIL),
3) Highmark Credit Information Services Ltd. (Highmark) and
4) Equifax Credit Information Company Pvt. Ltd. (Equifax).
All these companies are operating in India as per the guidelines of Reserve Bank of India.
The banks and financing companies are members of either one or multiple of these CICs. As per the contract, the bank and financing companies have to share the data of their customers to CIC on monthly basis. The CICs anaylse these data and come out with the credit score.
Credit Information Report
A details analysis for each client is also provided along with the score which is known as Credit Information Report (CIR). It does not contain details of clients savings, investments or fixed deposits. But, complete details of credit history across various lenders and products such as home loan, automobile loan, credit card, personal loan, overdraft facilities etc. The individual or members of CICs can buy this report for their reference. The report contain information like,
- name, date of birth, gender and identification numbers such as PAN, passport number, voter’s number.
- address and telephone numbers ; up to 4 addresses are present.
- monthly or annual income details as reported by the Members (Banks and Financial institutions).
- the details of your credit facilities, type of credit facilities (home, auto, personal, overdraft, etc.), account numbers, ownership details, date opened, date of last payment, loan amount, current balance and a month on month record (of up to 3 years) of payments.
- number of ‘Enquiries’ made recently.
How to Improve Your Credit Score?
As the banks and financing companies shares the borrowers data to CICs, it reflect how the borrower behaved during the month. Whether he repaid the instalment or they were delayed, whether he or she has taken a new loan, whether he or she is ensuring for new loan etc. Based on his financial behaviour, CIC will throw the score. It may be better than the previous one or worse. Therefore it is utmost important for clients to maintain a consistent financial behaviour so that credit score does reflect badly about financial condition and behaviour.
You may follow the following steps to keep your credit score better.
- Always pay your dues on time: Late payments are viewed negatively by lenders. Six months of on-time payments is required to see a noticeable difference in your score.
- Keep your balances low: Always be prudent not to use too much credit, control your utilization. If you have credit card accounts, call and inquire about a credit increase. If your account is in good standing, you should be granted an increase in your credit limit. It is important not to spend this amount so that you maintain a lower credit utilization rate.
- Don’t close a credit card account: If you are not using a certain credit card, it is best to stop using it instead of closing the account. Depending on the age and credit limit of a card, it can hurt your credit score if you close the account. Say, for instance, that you have 10,000 in debt and a 1,00,000 credit limit split evenly between two cards. Therefore the credit utilization rate is 10%, which is good. However, closing one of the cards with credit limit of 50,000 would put your credit utilization rate at 20%, which will negatively affect your score.
- Maintain a healthy mix of credit: It is better to have a healthy mix of secured (such as home loan, auto loan) and unsecured loans (such as personal loan, credit cards). Too many unsecured loans may be viewed negatively.
- Apply for new credit in moderation: You don’t want to reflect that you are continuously seeking excessive credit; apply for new credit cautiously.
- Monitor your co-signed, guaranteed and joint accounts monthly. In co-signed, guaranteed or jointly held accounts, you are held equally liable for missed payments. Your joint holder’s (or the guaranteed individual) negligence could affect your ability to access credit when you need it.
- Review your credit history frequently throughout the year: Monitor your score and report regularly to avoid unpleasant surprises in the form of a rejected loan application.
Your credit score is one number that can cost or save you a lot of money in your lifetime. An excellent score can land you lower interest rates, meaning you will pay less for any line of credit you take out. But it’s up to you to make sure your credit remains strong so that you can have access to more opportunities to borrow if you need to.