Even a self-sufficient person requires loan for one reason or the other. However, there is a certain factor which determines whether you have the necessary borrowing power to avail of such loan. This factor is nothing, but your credit score, which portrays your timely repayment capacity. In India, banks and financial institutions are bound to check your credit score prior to lending you any money. Therefore if you have a poor credit score, your borrowing powers are in danger. Thinking about your credit score? First let us understand what is credit score? and how it affects you?
Credit score is mainly a three-digit number which determines your credibility based upon specific parameters. These numbers typically range in between 300- 900, where more the score better the credibility. These scores are determined by agencies that record your payment history and thereby generate the credit report. In India there are only four authorized companies, which are known as credit information firms, namely- Equifax, Experian, CIBIL and Crif High Mark. These four companies have been granted permission by Reserve Bank of India (RBI) to operate as the credit information company aka credit bureau. These entities collect data relating to payment of loans and credit card bills of every individual as well as commercial entity as the case may be. These companies are governed by strict regulation of Credit Information Companies (Regulation) Act-2005, therefore any question of bias or false report is put to bed.
Now let us look at factors that may affect your borrowing power:
Factors that impact your credit score
Payment History: The first and foremost factor impacting your credit score is your payment history. Nearly 35 percent of your credit report comprises this part, wherein history is used to predict the future. Matters such as number of missed payments, frequency, and amount of missed payment are generally looked into while studying payment history.
Credit utilization: This generally pertains to credit cards and its utilized capacity. Every credit card comes with inherent credit limit and usage closer to exhaustion results into poor credit score. For example, if your credit limit is Rs45,000 and its utilized capacity frequently hovers around the Rs40,000 mark will result into poor report. Even though you are in limit of the credit allotted to you, it gives an impression of mishandling of your debt. Therefore paying in cash sounds much better than swiping your credit card.
Credit Mix: It relates to mixture of different loans and the capability to service all of them in time. A general perception says known devil is better than unknown God, likewise, a person with no credit card or payment history is dangerous than person who has managed different debts responsibly. According to the credit bureau, it easier to determine the credibility of the person through historical data. Therefore having history is better, and having sound history is beneficial.
Multiple enquires: Multiple credit application conveys your credit requirement and creates a negative impact on your credit score. When you apply for new loan or credit card when your existing loan or credit cards outstanding are higher, it will hamper your borrowing power. Bank judge you by your existing loan amounts and your financial power to cater the additional along with existing loans.
Length of credit history: Similar to credit mix, person with longer credit history is considered more secure than a person with shorter credit history. Since longer the period more the information becomes accessible and creates a better picture of his/her financial behavior. However, a person with shorter history will not be overlooked, if they have excellent repayment record and low credit utilization.
Now, since you know what credit score is, let us look at few tips to improve it, so that the next time you visit bank, you enter without a hint of doubt in your mind.
Payment of credit card bills or loan EMIs before due date, as delayed payments are worst for your credit score. Avoid multiple credit application, since it creates an image of excessive credit requirements and hamper your score unnecessarily.
Don’t exhaust credit limit, just because it has been given, instead try and maintain a minimum of 50 per cent of unused credit limit in your card.
Maintain optimum mixture of secured and unsecured loans, in order to achieve balance, since more unsecured (personal) loans may create negative impact on your credit score.
Keep check on guarantor or co-signed accounts, as in case of default by the initial or other co-signed borrower, you become immediately liable for the dues. Further, owing to your credit report the initial or other co-borrower have been sanctioned the loan, and any default can have severe impact on your credit score.
Keep in check your credit score least every six months, in order to save yourself from loan rejections. Further, it will also create an awareness to pay your bills on time. Banks use different criteria for different loan, for example, if a car loan is applied then more prominence will be given to your credit history than any other factor. Each bank or financial institution has different criteria to obtain the credit report, therefore it is advised to follow all above tips and be rest assured. A healthy credit score not only makes you eligible for additional loans, but also entitles you to cheaper loans.
The author is head and founder of Mumbai-based financial advisory firm Money Mantra. He can be reached at email@example.com