An individual has to meet a lot of requirements while applying for a business loan in India. One of such requirements is to provide CIBIL Transunion Score to the lender. CIBIL score is nothing but the credit score of an individual. Credit Intelligence Bureau of India, commonly referred to as CIBIL, generates the CIBIL score for an individual. It collects and maintains records of all credit activities of individuals and corporate institutions. The information regarding credit activities include credit cards and loans . All of the member institutions of CIBIL submit credit activity reports to the bureau. The bureau further uses this information to issue credit reports and credit scores.
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What is a Credit Score?
Credit score of an individual comprehends the amount of credit risk a lender bears while giving additional loan to such an individual. The Credit Score is a three digit number that ranges between 300 – 900. Closer is the score to the upper limit i.e. 900, more financially responsible an individual is deemed to be. A high credit score of an individual gives confidence to the financial institution. This is because the financial institutions gets positive about the individual’s loan repaying ability. Thus, a financial institution considers a score above 750 as a good credit score. Whereas, it considers a score above 800 as an excellent credit score.
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Why is a Good Credit Score Necessary?
Needless to say, having a good credit score is an absolute necessity. This is because financial institutions get the confidence in your financial abilities and consequently your loan repaying ability. This makes them pass on the benefits like higher loan amount, low interest rates, longer repayment period, faster loan approval etc to you.
Understanding the Credit Score Range
As mentioned above, your credit score ranges between 300 – 900. The breakdown of the credit score range is as follows:
Outstanding Credit Score (800 and Above)
Candidates having a credit score in this range are considered highly financially sound and responsible. Lending institutions are able to trust them and extend credit quickly based on their good credit scores. The financial institutions extend loans to such individuals at lower interest rates and without making delays. Such candidates are one of the choicest customers of the lending institutions. This is because they have little or no history of delayed bill payments. Thus, candidates with good credit scores are considered to have least risk of defaulting on loan repayments.
Good Credit Score (Between 700 and 800)
The financial institutions consider the candidates having a credit score in the range of 700 to 800 as good borrowers. These lending institutions considers such borrowers as financially responsible. However, such borrowers may have a history with one or two late or non payments. But on the whole, such candidates have been making loan repayments and credit card bill payments on time. Lending institutions extend credit to such borrowers easily. However, they extend credit at slightly higher interest rates as compared to their prime borrowers.
Average Credit Score (Between 500 and 700)
Borrowers having a score between 500 to 700 have an average credit score. Now, if you are one of them, this means that you have to really work towards improving your credit score. Lending institutions do not extend credit easily to such borrowers. Hence, you need to make an effort to improve your credit score over time. Make sure that you pay your credit card bills on time, have a right credit mix and do not close old accounts for a longer credit history.
Poor/Bad Credit Score (Below 500)
Any score below 500 suggests that you have a bad credit history. Lending institutions attach high default risk with such borrowers given their non – payment of loan amounts, default accounts etc. Thus, such borrowers are outrightly rejected by lenders owing to their poor financial health.
How is Your Credit Score Calculated?
CIBIL is the premier credit information company in India. RBI has authorized three more credit information companies to issue credit reports and give credit rating apart from CIBIL. These companies include Equifax, Experian and HighMark . Thus, all financial institutions have to submit credit activity records to these credit information companies periodically. Furthermore, each credit information company has its own algorithm to calculate the credit scores. However, each of them considers some common factors while calculating the credit score of an individual.
a. Your Past Credit Performance
This is the most important factor while calculating your credit score. It holds the maximum weightage of 35% in the total score. So, what exactly makes your credit history? Your credit history could mean your payments towards Equated Monthly Installments, bills and credit cards. Thus, timely payment of installments and bills is taken as a good credit history. And this positively impacts your overall credit score. But, it is difficult to get a good credit score in case you delay or do not pay EMIs and bills.
b. Credit Utilization Ratio
This accounts for 25% of the total credit score. Now, there are two things that go into the calculation of this ratio :
- Your Credit Exposure
- Your Credit Limit
Credit exposure is the amount of loan outstanding or credit that you have already taken or are using currently from the financial institutions. This is the amount that you ought to repay the banks, NBFCs or other financial institutions who have extended credit to you in some form or the other.
Credit Limit, on the other hand, is the total credit limit available to you. To better understand how credit utilization ratio works, here is an example.
Say you have four credit cards, each with different revolving credit limits.
Card 1: Revolving Credit Limit – Rs. 1,00,000 ; Credit Utilized – Rs. 30,000
Card 2: Revolving Credit Limit – Rs. 60,000; Credit Utilized – Rs. 20,000
Card 3: Revolving Credit Limit – Rs. 1,50,000; Credit Utilized – Rs. 40,000
Card 4: Revolving Credit Limit – Rs 75000; Credit Utilized – Rs. 50,000
Thus Total Credit Limit = Rs. 3,85,000
Total Credit Utilized = Rs. 1,40,000
Therefore, Credit Utilization Ratio = 36.36%
c. Type of Credit and Duration
Your credit mix, that is, the amount of secured loans vs unsecured loans, also impacts your credit score. This has a weightage of 25% in your credit score calculation. Secured loan has a collateral attached to it. So if you are unable to repay secured loans, lenders have the right to take possession of the collateral you agreed upon. Home loans and auto loans fall in this category.
Now say if you have more secured loans in your credit mix and you have been making timely payments of your secured loan installments. This will be taken as a healthy sign and would positively impact your credit score.
Unsecured loan, on the other hand, is the one that does not require a collateral to be given. Credit cards, student loans and personal loans come under unsecured loans. In such a case, if you are unable to repay the loans, lenders cannot take possession of any of your assets. That is why, if you have higher percentage unsecured loans in your credit portfolio, your credit score comes down, even if you have been making timely repayment of the same.
In addition to the type of credit, the duration of your credit also impacts your credit score. How long your accounts have been open, how long its been since these accounts were used all are taken into consideration while calculating credit score. Longer credit history leads to higher score. Well, that is not so say that people with shorter credit history cannot have a credit score equal to those with longer credit. But yeah, for credit score to be calculated, you need to have some credit history.
d. Other Factors
These amount to 25% of the credit score. These include the number of loan applications made with different financial institutions over a period of time. Higher number of applications negatively impact your credit score. This is because it gives an indication to the credit information company that the applicant is desirous of more credit.