Credit score is often a 3-digit score ranging from 0-900 points. It is a summary of your credit history arrived at by considering an individual’s credit and repayment history over a period. The credit information report has absolutely no relation with your savings and / or investments like FDs, SIPs etc.
Importance of a good credit score
A higher credit score means a better chance of getting a loan and possibly better rates of interest as well. A credit score will tell lenders how likely the person is to repay their debts.
How is a credit score calculated and who does it?
Inputs from the banking & finance institution with which the customer has secured and / or unsecured loans is passed on to the major credit bureaus like TransUnion, Experian, Equifax etc. These inputs are used to create the individual’s credit report and in turn used to create a credit score. In India, we have the CIBIL score, which is a part of the TransUnion. An individual’s credit report contains all information pertaining to secured & unsecured loans of past & present including the status of timely payment and / or default. Credit Scores from different bureaus have slight variations in how they are computed, but most of them, including CIBIL, give weightage to the payment history as a significant factor. Other factors include age, gender, length of history, credit mix, credit utilization, etc.
We are going to focus on the CIBIL Report as currently any leading lending institution takes into consideration the CIBIL score only.
Understanding your CIBIL Report
Your CIBIL report will consist of following information:
1. Personal information: Contains your name, date of birth, gender and identification numbers such as PAN, passport number, voter’s number
2. Contact information: Upto 4 addresses and telephone numbers
3. Employment information: Income details as reported by financial institutions
4. Account information: This has all the information of your credits including name of lenders, type of credit facilities like 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 your payments
5. Enquiry information: Every time someone applied for a credit card or loan, the bank / financial institution will access your Credit information. These are reflected in your report.
Factors affecting CIBIL score
1. Improper payment history: Missed or overdue payments can reflect in a bad way on your total score. If you have multiple credit cards or loans, it is best to set reminders for timely payments.
2. Outstanding debt: Keeping unpaid dues will take a negative impact on your score. One should always make sure to pay off their outstanding dues.
3. Credit utilisation: It is recommended to keep your credit utilisation ratio under 30% of your available credit limit. Using higher credit might signal financial institutions that there is a higher risk of default.
4. Length of credit history: In short, a longer credit history means that creditors will be able to take a better decision on your applications. Before taking a car / housing loan, it is better to build up a credit history.
5. Having both secured and unsecured loans: It is a good practice to have both secured (home loan, car loans, etc.) and unsecured (credit cards, personal loans, etc.). Having both of these shows that you have experience of both types of credit lines and lends confidence to banks and other financial institutions.
6. Multiple applications for cards, loans in a short time: Every time you apply for a new credit card or a loan, the institutions will make an enquiry on your CIBIL. Multiple such inquiries in a short time could affect your score negatively. If your credit card has been declined, it is better to wait for a while before applying for a new one.
What does a score of 0, -1 or one between 1-5 mean?
0: No credit history available
-1: No credit history available, but borrowers track record is less than 6 months
1-5: CIBIL’s risk score for new borrowers where 5 is the lowest risk and 1 is the highest risk
Tips to maintain a higher CIBIL score (if your score is below 700)
1. Have a good payment history: If you miss a payment or get late, its best to contact the lender and work out some way if possible, rather than get a negative impact on your report.
2. Reduce outstanding: Reducing the total debt you have will increase your score. It is also a good move to reduce the number of credit cards (only if you have a score less than 700).
3. Reduce card utilisation: Avoid putting up charges of your credit cards if you plan to get a home or car loan. If you are planning to get a loan, try to clear any outstanding amount you owe.
4. Improve length of credit history: The longer you have a credit history, the better the chance of an improvement in the CIBIL score. A short history will not cause any issues, however, will score lesser than if you had a longer history.
5. Take a loan and payback in full: If you plan to make purchase outright, it is better to take a loan against it and pay it back in full after the loan appears on your CIBIL.
Updates to the CIBIL algorithm
While the exact algorithm is not revealed, recently there have been changes made to the factors affecting a person’s credit score. The most important one is the 3-year account history verses the 2 year earlier. New reports will now factor in a 3-year account history. There have been some other changes as well, and the general consensus is that scores have fallen by 20-30 points. This is not a major factor, as your score is only a part of the report that financial institutions make use of when determining whether to grant you a loan or not.