What Are Credit Scores and Why Are They Important?
So, picture this– After nearly waiting for an hour and a half at the bank, you are finally called for at a booth. But then 10 minutes later another person attends a booth next to you and leaves within the next 20 mins. Meanwhile, your papers are still being assessed and you just can’t figure out why it is taking so long. And after an hour-long ordeal, the staff finally states that you are being offered the home loan, but at an unreasonably higher interest rate. The shiny billboard outside suggests that the bank shall be issuing the first-time lowest interest rates, then why are you being issued such high rates? Is it a bias? Are you being duped?
The answer is– Credit Score! The implication is that the person who came after had a substantial credit score that let him avail the loan in a matter of few minutes. While your papers were evaluated at every nook for any misconduct, given that you have a lower credit score.
This is a gradation system that simply denotes whether you abide by the credit regulations– are you regular on your credit card payments, EMIs, Debt, mortgage, etc.?
Who decides these credit scores?
There is a third-party system that assesses all your financial transactions and credit payments. Credit Bureaus determine the appropriate credit ratings for people and businesses, after analyzing the overall data of your “timely” repayments and proper proof of the same. These transactions may include–
- Overdraft Facilities– withdrawing more money than your available account balance (the bank charges a certain interest rate on these withdrawals as well).
- Income Taxes
- Utility Bills
- Loans Taken
This data is collected from the lending companies, credit issuers, and Data & Money collection agencies. By evaluating this data, the credit bureaus determine a specific behavior of the person when it comes to their default history of payments, Credit Utilization, Credit duration, New Credit Inquiries, and the debt-to-income ratio: correspondence between your monthly income to monthly payouts for repayment of debts.
Following are the credit agencies in India:
- TransUnion CIBIL ltd
- Experian Credit Information Company of India Private Limited
- CRIF High Mark
- Equifax Credit Information Services Private Limited (ECIS).
|Point to be noted: New Credit Inquiry includes– ~Hard Inquiry: too many of such inquiries will negatively impact your credit score as they are mentioned in your credit report. ~Soft Inquiry: does not affect the credit score as they are not attached to a specific application or credit.
How do these Credit Ratings work?
These aforementioned agencies have variants of a rating system. But to give a basic idea, here are a general breakdown of how much credit score is good:
|High Worth individual
|Lowest interest rates and easiest approval.
|700 – 749
|Rates Comparatively higher than the above category, but easy approval.
|650 – 699
|Limited options but approval is possible after a thorough assessment.
|600 – 649
|On the edge
|Higher Interest Rates and harder approval on loans.
|You need to take immediate action to develop a healthy credit score.
How to secure a good credit score?
It all depends on how you manage your personal finances; maintaining a healthy habit of timely repayments is half the job done– the credit scoring system awards 35% weightage to only the repayment habits; to secure a good credit score you must first maintain a 100% record in repayments.
Other factors that positively affect your credit score are:
- Keeping the utilization low
Some of us have experienced that our credit cards max out, right at the cashier’s checking counter. This indicates to the rating agencies that you have used your credit limit and defaulted on payment dues; which may work against your credit score.
|Pro tip: It is recommended that one must maintain their credit utilization up to 30% which will help to gain a good credit score, gradually.
- Diversifying the credits
Put an assortment of credits under your credit card for both secured loans and debt products that aren’t guaranteed with collateral. This reflects positively on your credit report.
- Your credit history timeline
Your credit score is directly proportional to the length of owning that credit card. The more you borrow and maintain sustainable repayments throughout an extended period of time, the easier it is for lenders to evaluate your credit behaviour over that duration; thus reflecting in your overall credit score.
- Avoid subscribing to multiple credits
If you apply for multiple credit cards simultaneously just for a better bargain, this may actually reflect negatively on your credit score. Every application raises a hard inquiry by the lender.
Moreover, if one lender rejects your application, then this may discourage another lender as well. This marks a setback in your credit report.
- Discontinuing old credit cards
Unused credit cards can be tricky coz even though they are not active at present, yet they have still accumulated substantial credit over the long duration. In case you close that card, your entire credit score can tumble down. To avoid unwanted debt, weigh your options first.
- Don’t get used to only paying minimum dues
Credit cards often have a policy where you can pay 5-10% of the total amount as a minimum due, while the rest will be carried forward on the next cycle. While this may help your personal finance temporarily; the interests pile up in the long run. Owing to this, it is advised to make full payments on the due date, which also secures your financial health by controlling your utilization.
- Score-builder credits
One concern that often arises for young professionals is how to develop a credit score when they have no income to start borrowing. There is a separate segment called “Score-builder loans” that offer small loan amounts to get people started on building their credit scores. If you exhibit disciplined timely repayments, this helps in building a positive credit report, which will further help you in availing loans.
What is Credit Risk?
|Case study: In 2008, when the US housing market bubble burst, it catapulted a worldwide financial crisis. The premise was simply that the lenders were handing out loans to people with low credit scores and also high credit risk. Moreover, the same financial institutions started trading these loan bundles as securities backed by credit default swaps (CDS). With this, the lenders could easily pass along these mortgages from their responsibility, while also taking away risk from them… within a couple of years, the failure of these loans + the securities that depended on the mortgages crumpled down like a house of cards. Lakhs of foreclosures and a subsequent financial crisis erupted based on “credit scores and credit risks”, costing millions their houses and jobs. At that time, credit rating agencies also played a significant role in influencing these subprime loans.
To avoid such deregulations, RBI has mandated credit bureaus in India to maintain transparency in the rating system and also calculate the risk involved with the individual/ organization.
Consumer credit risk is measured on these factors:
- Credit History
- Whether the individual can afford to repay
- Total capital
- The conditions levied with the loan
Make sure you map out your finances to avoid the credit risk.
What are the benefits of a healthy credit score?
- The primary benefit of a good credit score is that you can avail loans quickly during emergencies.
- You enjoy lower interest rates on your EMIs and when compounded values up to significant savings.
- A good credit score is a great incentive for home loans. With several upcoming areas in Pune for real estate investment, it is a perfect opportunity to use your credit score for your dream home.
- If you are looking for a good real estate investment in Pune, then Kolte Patil Developers have an assortment of projects backed by top banks at lower interest rates.
Q1: How can I apply for an online credit report?
A: Most credit rating agencies allow to access credit reports for free. Just log in to their website and fill in the essential details; which mainly include–
Name, address, D.O.B, PAN card number, and Identity authentication
Q2: What does NA or NH mean on my credit report?
A: NA or NH denotes that there is no or very little activity on your credit history– which means you have not yet borrowed or never owned a credit card.
Q3: Will my credit report also include my personal banking details?
A: No checking or savings account details are included in this report. Only the information related to your credit is included.
Q4: Is my credit report available as public information data?
A: Not at all! In fact, only you, the lender, and the regulating authority under the government can access this vital info.
Q5: Will my credit report have a default from many years ago?
A: Once a default is reported, it is marked on your credit report for over 8 years.
Q6: Where should I report if I find certain errors in my credit report?
A: You can directly contact the credit bureau that assigned the report via phone, email or other mediums.
Q7: If I pay my dues, do I get an instant boost on my credit score?
A: This record may help in avoiding the fall of your credit score, but it definitely does not boost the score. To maintain the credit score, one needs to practice timely payments, which will eventually lead to higher score over a period of time.