A 3-Step Credit Score Guide (That Everyone Needs To Know)
CHAPTER 1: What is a credit score?
A credit score is a numerical, three-digit number that reflects your creditworthiness as an individual. Many agencies like TransUnion CIBIL, Experian, CRIF High Score, and Equifax calculate credit scores for personal loans. The credit score of TransUnion is popular; most lending institutions use this score to assess the creditworthiness of borrowers.
Let us use CIBIL scores better to understand the classification of credit scores and profiles.
We can classify a CIBIL score into four categories. It ranges from 300 on the lower side to 900 on the highest. The classification of the credit scores is as follows:
|Credit Score Range||Rating|
Credit scores are determined when financial institutions and banks submit individual and organisation data to the credit bureaus. The submitted data include outstanding balances on new and other credit applications, repayment schedules, and default history. Based on this data, credit rating agencies estimate your credit score.
The Privo app from Credit Saison India sanctions loans based on your credit score, which should be 650 or above. A 650+ score is considered a good credit score or an excellent rating. A higher credit score ensures a greater probability of your loan receiving approval.
CHAPTER 2: Top 5 factors that commonly make up your credit score
How is credit score calculated, and how to increase your credit score?
The credit score calculation attributes the following weights to different factors typically:
|Credit Score factor||Weightage attributed|
|Length of credit history||15%|
As explained above, credit scores are determined based on the following factors:
- Payment history: Credit reporting agencies analyse your payment history against your loan repayment schedule. You should make consistent payments towards your outstanding loan and interest balances to have a good credit history. They also consider your collection history, defaults and any bankruptcies. The greater the number of issues in your credit history, the more it will impact your credit score.
- The amount owed: This metric measures the current outstanding loan balance and interest payments on your different loans. Credit utilisation measures the amount borrowed by you divided by your overall credit limit. Typically, borrowers who borrow up to the maximum limit or the entire amount of their credit limits are considered potential risks. Usually, lenders prefer the borrowers’ credit utilisation ratio to be within 30% to consider such borrowers’ reasonable credit risks. If this ratio is high, you’re considered to have high debt from various sources.
- The credit history length: A long history of borrowing and making regular payments improve one’s credit score. On the other hand, if we default on our payments or have a short credit history, credit rating agencies cannot reliably assess our payment and default track record. Your credit score depends on this assessment.
- Credit mix: This implies that we borrow loans for different purposes from different lenders. We have credit card debt and mortgages on homes and vehicles. We may also have multiple credit cards from various banks because we want to optimise the benefits, incentives, and reward points. With the increased ease of shopping, the digital age has seen a lot of online transactions. We also have large loans for our house, vehicle, travel etc. If you are someone who regularly applies for new credit, it reduces your repayment capacity. You may take secured and unsecured loans, resulting in the pledging of your assets. The larger the overall outstanding debt, the overall credit score will reduce.
- Employment history: Your employment history matters because you may have an irregular employment history with short employment stints with multiple employers or you may have periods of unemployment between jobs. Both cases will affect the steadiness of your cash inflows and profiles you as a high-risk borrower. A long and steady employment history also shows that you are at a reasonable risk as you have a stable income and can make regular payments towards your outstanding amounts.
Obvious truth: Missing Payments
The credit score gives the highest weightage to your repayment pattern. If you regularly miss making payments, such an irregular payment history or default in your payment pattern will result in a lower credit score. It will affect your future capacity to borrow.
The longer your loan payments are missed, or defaults occur, the more significant the impact on your credit score. Your accumulated debts will signify that you cannot pay.
CHAPTER 3: Myths about the negative effect on credit score
- Your annual income influences your credit score:
This factor does not impact your credit score. Whatever your credit score, if you are disciplined in making your repayments and show a reliable repayment history, your credit score will remain unimpacted. On the other hand, if you have a high income but are profligate in your spending habits and have no discipline in your spending behaviour, your credit score will automatically be low.
- Regularly tracking your credit score will keep it low:
If you regularly follow it, you can take appropriate measures to improve your credit score. You can improve your payment schedule and make regular payments on time. It will prevent any defaults and help you to reduce your outstanding and improve your credit score.
- A credit score is the sole determinant of loan approvals by a lender:
A credit score is undoubtedly vital in determining your creditworthiness, but it is not the sole determinant. You already saw the range of weights assigned to different factors above. You must monitor and regulate your standing in those various aspects carefully.
- Closing old accounts will boost your credit score:
If you have multiple credit cards, you may be under the mistaken impression that closing the old, unused credit cards will improve your credit score. It is a myth because credit scores are affected more by your regular payment patterns and lack of default history. An unreliable repayment pattern affects your credit score more. Also, reducing your outstanding debts and EMIs will help enhance your credit score.
- Use of debit cards will help to enhance your credit scores:
This is a fallacious assumption, as when you use your debit cards, you use your own money in your accounts. There is no loan generated or credit history triggered. Only your borrowings, loan history, and repayment history will determine your credit score.
- Credit repair bureaus will help you to improve your credit score:
If you find faults in your credit history, the credit bureaus will assist in raising it with the credit rating agencies and rectifying the weaknesses in your credit history.
Credit repair bureaus do not assist in repairing your credit history. You can only do this through prudent financial behaviour, establishing a disciplined borrowing pattern and responsible repayment. Only this financial discipline can help you to raise your credit ratings.
- You can wipe out your old transaction history with responsible payment of your debts:
It is also a myth. Once you create a credit history, it remains together in the credit assessment system for years.
Credit rating agencies will use your past credit history to underwrite your credit reports and provide them to lenders. It enables lending institutions to make a calculated decision about whether to lend to you or not.
- Applying for a new credit card can affect your credit score:
Applying for a new credit card alone will not affect your credit score. The lender will make a hard inquiry into your credit history if you have multiple credit cards. Also, avoid sending various credit card applications. It will give rise to numerous hard questions. It will not improve your credit history.
- A bad credit score is a permanent blemish on your credit history and cannot be improved:
This one is another mistaken impression. If your financial behaviour improves and is consistent in the future with regular repayments and no defaults, your credit score will improve. As mentioned above, your prudent financial management and prompt payments of debts will significantly help to improve your credit history.
The Privo app provides instant personal loans and lines of credit to borrowers with credit scores above 650. Monitor your credit history, enforce prudent financial discipline, and follow the above principles in your borrowing and repayment behaviour. Then there is no reason why an RBI-regulated instant loan app like Privo will reject your loan application. Take a tour here: https://bit.ly/3MqFHc0