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What is Credit Score? Its Benefits and How to Improve it?

credit score

Introduction

A credit score is a measure of one’s creditworthiness. A higher credit score indicates a better ability to repay a loan. Additionally, it can get faster loan approvals, cheaper interest rates and better bargaining power. Whereas, a lower score will reduce the probability to get credit cards and loans. In this article, we have covered all about credit score in detail.

What is a credit score?

A credit score is a measure of an individual’s creditworthiness. In other words, it means an individual’s ability to repay the borrowed amount. It is a three-digit number ranging from 300 to 900, with, 900 being the highest and 300 being the lowest.

Having a high credit score can help individuals get loans and credit cards faster. Additionally, it can help one get loans at a cheaper interest rate, or higher loan amount, or they get to choose the tenure to repay the loan.

Credit score calculation of an individual is done after taking into account several factors. Some of them being, credit balance, new credits, tenure, credit mix, credit utilisation, repayment history and credit enquiries. Major Credit Information Companies like CIBIL TransUnion, Experian, Equifax and High Mark compute credit score in India. Reserve Bank of India has mandated all banks to pass on any transaction related to calculating credit score to these four companies. The companies calculate the score based on the data provided and make detailed credit reports. A credit report is like a financial report card, and it contains the credit score of an individual.

It is always recommended to check one’s credit score from time to time. This will ensure one knows their chances of getting a loan. Additionally, individuals can keep track of their score and report any mistake in the calculation (if any) to the Credit Information Companies.

What impacts your credit score?

The credit score of a person depends on various factors. Primarily it reflects an individual’s credit behaviour. This includes credit repayment history, frequency of loan application or credit card application, a mix of secured and unsecured credit, etc. Following are some of the major factors that have an impact on a person’s credit score:

Repayment history

It means credit repayment history. In other words, timely repayments of bills, EMIs, etc. have an impact on the credit score. Missing any payments will harm the score and also on the ability to secure a new credit in the future.

Credit utilisation ratio

The credit utilisation ratio is the total amount of credit taken by the available credit limit. A high ratio indicates high repayment burden, and this harms the credit score. On the other hand, a low credit utilisation ratio (30% or less) implies high creditworthiness for a lender. Also, one can avail additional credit with ease.

Simultaneous credit card and loan applications

Usually, new loan or credit card applications trigger enquiries from the lenders. Also, these enquiries by the lenders show in the credit report, which in turn has an impact on the credit score. Therefore, multiple hard enquiries hurt the credit report.

Credit Mix

Having the right mix of secured and unsecured loans is a good practice. For example, having too much of unsecured debt such as credit card bills or outstanding personal loans will have an impact on the score. Having a high unsecured debt reflects on the credit behaviour of mismanagement of personal finance. Hence, it’s good to have a mix of secured loans (home loan, gold loan, loan against property, mortgage loans, car loan, business loan) along with some unsecured loans (student loans, credit card debt). This helps in maintaining a good credit score and also increases the chances of getting new credit.

Frequently increasing the credit card limit

Frequently requesting for an increase in the credit card limit will result in too many hard enquiries. The more number of hard enquiries will adversely impact the credit report and the score. Also, this may be perceived as high dependence on credit. Also, the potential lender may perceive this as high chances of credit default in the future.

Credit reporting error

Incorrect information in the credit report will hurt the credit score. For example, incorrect default payment information, loans or credit cards assigned, mistakes or errors in personal information, etc. Moreover, delayed or inaccurate reporting by banks can also hurt the score.

No Credit History

Credit history is determined on the basis of credit behaviour, credit utilisation limit, repayment history, etc. Having no credit history will have a negative impact as the lender doesn’t have any proof to determine and estimate the risk of non-repayment.

Unable to fulfil the loan guarantor role

As a loan guarantor if an individual is unable to fulfil the liability of someone else’s loan default. This will harm the loan guarantor’s score. In other words, the primary borrower fails to fulfil the loan obligation and then the loan guarantor also fails to repay. The credit score of the loan guarantor will have a negative impact.

Credit Score Range and how to interpret it?

The credit score ranges between 300-900, and one must ensure their score is closer to 900. This will ensure they will get good deals on their loans and credit cards. Understanding credit score and interpreting it will help in obtaining loans quickly. Following are the ranges and their meaning:

No History (NH) /Not Applicable (NA)

For the Credit Information Companies to calculate a credit score, they would need information. If a person has no credit history, then the score will be NH/NA.

300-549

A credit score in the range of 300-549 will indicate that the individual has defaulted payments in the past and has unpaid dues. It also indicates that the individual is not a responsible borrower. A score in this range is considered as bad.

550-649

A score in the range of 550-649 is considered as average, and one has to take measures for building it. It is difficult to get credit cards and loans with this credit score.

650-749

A score in the range of 650-749 is considered a fair credit score. One can get loans and credit cards but will not be in a position to negotiate a fair deal.

750-900

A score in the range of 750-900 is considered excellent. One can easily get loans and credit cards. Additionally, they will be in a position to negotiate the interest rate, payment terms, tenure and get credit cards with better rewards and benefits.

The two major credit score companies in India are CIBIL and Experian.

CIBIL Score

The CIBIL score is a three-digit number ranging between 300-900. It gives a summary of credit history. A higher CIBIL score will help individuals get loans faster and at cheaper rates. A CIBIL score of 750 and above is considered ideal, and one can get loans quickly.

Experian Score

The Experian score is a three-digit score ranging between 300-850. A score of 800 and above is an excellent score. Any score above 700 is good. One can get loans easily with this score. The credit score ranges slightly vary for Experian. A score of 300-579 is a low score. A score of 580 to 669 is a fair credit score. And a score of 670 to 739, 740 to 799, and 800 to 850 are considered to be good, very good, and excellent respectively.

Myths about credit score

Following are the most common myths about credit score:

Credit report and credit score are the same

A credit score is a numeric value that reflects an individual’s creditworthiness. The score is determined upon considering various factors with respect to the repayment of debt and credit profile. Moreover, a credit score is only a part of the credit report. A credit report covers an individual’s entire credit history, pertaining to loans and credit cards.

One cannot receive credit if they don’t have it already

Lenders often check an individual’s credit score and history before granting the credit. They mostly refer to the credit reports generated by the credit information companies. However, in an instance where there is no established credit history of an individual, one can always get someone to authorise or co-sign the loan. For example, if there isn’t anyone to co-sign or authorise the credit, one can always get a secured credit card. A secured credit card requires one to put cash as collateral. Using a credit card will help in establishing a credit history.

A credit score is the sole determinant of an individual’s ability to secure credit

Most people misinterpret that credit score is the sole factor to determine an individual’s ability to secure debt.  Hence understanding credit score becomes important. Credit report and credit score are often the first things that a lender considers before approving the credit. However, several other factors have an impact on lending decisions—for example, the lender’s internal criteria such as debt to income ratio, employment, etc. Thus, a sound or high score doesn’t necessarily guarantee loan approval. Similarly, a low score doesn’t always guarantee denial of new applications of loans.

Checking the credit report hurts the credit score

Checking the credit report often will not impact the credit score. Reviewing a credit report will be recorded under the soft enquiry section. The soft enquiries have no impact on the score. The credit scoring models do not factor in for soft enquires. Therefore, it is good to check the credit report at least once a year.

Using a credit card can impact the credit score

It a popular misconception that using a credit card will negatively impact the score. However, it is only true when an individual misses or defaults the payments. In such scenarios, the score will have a great impact. Furthermore, using credit cards wisely will help in creating a good credit history. Which will ultimately lead to having a good score.

Closing a credit card improves the credit score

Closing a credit card account will not help in improving the credit score. It brings down the credit limit and in turn pushing the credit utilisation ratio. A high utilization ratio will lead to a lower score. However, it is good to use the credit cards wisely to maintain the credit utilisation ratio at 30% or lower.

An employer can check the credit score

In India, it is not a common practice for an employer to check the employee’s score. However, the employer can check it only upon seeking the employee’s approval. Also, such enquiries are considered as soft enquiries.

Education level, job profiles and high income can affect the credit score

Qualification, job profile and income levels do not have an impact on the score. Such information is not even captured in the credit report. A credit report has information about the debt. Also, the credit report will not have information about the certificate of deposits, savings accounts, etc.

The low credit score lasts forever

A credit score is just a credit history, and hence credit can be rebuilt over time. A credit score doesn’t just show the current way of things. It keeps a record of an individual’s credit from the time it has been opened. Late payments can stay on an individual’s credit report for up to seven years. Hence, building a credit score means making timely payments. Moreover, the longer the credit history has no negative information, the better. However, the older (negative) information will become less significant over time.

Paying off a debt means, it is clear from the credit report

Negative information like later payments, bankruptcies, or collection accounts remains in a person’s credit report for at least seven years. Also, certain bankruptcies stay for ten years. Therefore, paying off debt doesn’t mean that it is clear from the report. The credit report will update the debt status as paid.

There is only one score that all the lenders use

There are multiple credit scoring models available in the market. Most lenders use generic scores to determine general credit risk. However, certain lending institutions and businesses need custom credit information. A custom credit score predicts risk for a specific type of lending—for example, retail debt, auto loans, etc. Therefore, custom scores are unique and are specific to that time of lending or business.

Credit score from all the credit information companies is the same

Every credit bureau has its model to generate a credit report. Each of them have their own way to determine the score. Hence, the scores are rarely the same.

If one spouse has a good credit score doesn’t mean the other can avail credit on that

There is no such thing as a credit score for couples. Therefore, a couple where one spouse has a good score doesn’t guarantee credit to the other or jointly. There might be an instance of credit issuance with high-interest rates, fees, etc. However, there is no guarantee that couples can get joint credit because one of their scores is good.

How is a credit score calculated?

Each Credit Information Company has its algorithm to calculate the credit score of an individual. However, all four agencies consider the following common factors to calculate it:

Loan repayment history

An individual’s loan repayment history affects their credit score the most. A credit bureau (credit information company) keeps a month on month record of all payments towards bills and loan EMI. A single non-payment or late payment of a bill can pull down the score by 100 plus points.

Credit Utilisation Ratio (CUR)

Credit Utilisation Ratio (CUR) is a measure of usage of available credit in a credit card. The more the CUR, the higher will be the impact on the credit score. A high CUR will reduce an individual’s score. Ideally, one should keep their CUR below 30% to maintain a good score. Additionally, for the used credit, one has to ensure timely payment of credit card dues.

Credit mix

The type of credit also impacts the credit score. A balanced credit mix will boost a person’s credit score. A balanced credit mix will have an adequate mix of secured (home loan, gold loan, loan against property, mortgage loans, car loan, business loan) and unsecured loans (education loan, credit card debt). Having more unsecured loans will drag the score down.

Duration of credit

The duration of a particular credit line is important while calculating a credit score. The older the loan or credit card is, the better will be the score. This will show that the individual is responsible towards the lenders and is making timely payments.

Number of credit enquiries

The number of credit enquiries will also impact the credit score. The more the number of credit enquiries on a person, the lower will the credit score. This is because, every time an individual wants to take a loan or refinance an old loan, the new lender will check their score. To check the score, a legally permitted enquiry has to be made. Hence more the number of enquiries, shows the person is credit hungry and might reduce their credit score.

Benefits of maintaining a good credit score

Maintaining a good credit score can get a person more than just faster loan approvals. Below are the benefits of maintaining a good score.

Get the best bank credit cards

Having a good credit score will help an individual get the best bank credit cards with more rewards and benefits. Also, it helps them get a higher credit limit. This is because the banks will have confidence in the borrower’s creditworthiness and their ability to repay.

Quicker loan approval

Having a good score will help individuals get loans quicker. Their approval times will be lower for any loan, be it a car loan, personal loan etc. Additionally, they will have access to pre-approved loans. Also, having a good score is one of the main factors for loan eligibility.

Better interest rate

Having a good score will give the power to the borrower to bargain for a cheaper loan interest rate. They can get loans at a much cheaper rate than the market rate.

Discounts on loan-related expenses

Loans will have processing fees and other charges. Sometimes these tend to be on the higher side. Having a good score will help an individual to negotiate their way out of some of these expenses or get a discount on them.

Lower down payment and lower loan interest rate

Having a good score can lower the down payment requirement for any loan. Additionally, they can get the loan with lower interest.

Which are the credit information companies in India?

In India, there are primarily four credit reporting agencies that compute the credit information.

TransUnion CIBIL Limited

Formerly known as Credit Information Bureau (India) Limited, is India’s first Credit Information Company (CIC). This credit reporting agency was founded in the year 2000. The company collects and maintains records of individuals’ repayment habits with respect to loans and credit cards. The financial institutions and member banks send the reports to TransUnion CIBIL Limited every month. Information gathered from these institutions is used to generate the Credit Information Report (CIR) and credit scores. Furthermore, these reports and scores are then given to the lending financial institutions (like banks) to help them make lending decisions.

Experian Credit Information Company of India Private Limited

Experian Credit Information Company is a Dublin based company that creates credit reports. Experian’s credit report has information about an individual’s loan and credit history. Banks and other lending institutions purchase these reports. Similar to TransUnion CIBIL, Experian also collects data from its member banks and other institutions in India to generate credit reports.

Equifax Credit Information Services Private Limited (ECIS)

Equifax is one of the oldest and largest credit reporting agencies in the USA with headquarters in Atlanta. It provides credit reports to both individuals and businesses. The company partnered with many institutions and banks in India to help create credit reports and for assessing credit scores.

CRIF High Mark

CRIF high mark is among the few credit reporting agencies that specialises in scoring, analytics, and credit management solutions. It creates credit reports on the bases of the information that it collects from the Income Tax Department, banks and other banking and non-banking institutions. The CRIF High Mark credit reports are available against a fee. Many Indian banks have tied up with CRIF High Mark to generate credit reports and assess the borrower’s financial credibility.

What is a credit score report?

A credit report is a record of an individual’s history of managing and repaying debt. It is more like a report card that the lenders refer to before issuing credit to anyone. The credit report has a note of how and when the bill payments were made. It also shows how much debt a person has and since how long have they been managing credit accounts.

Lenders use a credit report to learn about an individual’s previous borrowing experience. These reports help the lenders make decisions with respect to granting credit. Credit reports also help in determining the credit score. Additionally, they help in verifying an individual’s identity and for other purposes in the limits prescribed under the law.

All credit information companies create credit reports. The information in a credit report is more or less the same. However, the way the credit bureaus represent the data differs.

What type of information is included in a credit report?

A credit report primarily has the following four categories:

Personal Information

This section has personal information about the individual.

  • Full Name: Details such as full name along with any variations in the name while availing credit. The variations in the name can also be with or without a middle name, surnames used before marriage or divorce, or nicknames.
  • Address: Current address, along with other addresses provided while opening credit accounts.
  • Employer details: Name of current and all past employers.
  • Joint applicant name: Names of individuals with whom the assessee has jointly opened credit in the past.

Accounts

The accounts section lists all the currently active or open credit accounts, closed accounts and turned over to collection accounts.

  • Open accounts: This lists all the open credit card accounts and loans. Additionally, this also has the payment history up to seven years of monthly payments. It has a record of whether all payments were made on time or past the due date. For all the late payments, the credit report will indicate if they were 30, 60, or 90 days past the due date.
  • Closed accounts: This includes all the paid off credit card accounts and loans either by the individual or by the issuer. Closed account details stay up to ten years after closure and show up to seven years of its payment history.
  • Turned over accounts: If applicable, it includes accounts turned over to property foreclosure, collections and repossessions of vehicles or merchandise. The list is a result of non-payment of the credit.

Enquiries

Enquiries are the requests from companies or lenders for an individual’s credit report. The list enquires stay up to two years in a credit report. Usually, there are two types of enquiries:

  • Hard enquiries: These are requests to check an individual’s credit associated with respect to new credit applications such as credit card or loan.
  • Soft enquiries: Soft enquiries happen for other reasons, such as to determine credit prequalification or check one’s credit. It may also be a result of companies that an individual has a relationship with checking the score.

Public Records

Public records, for example, include the details of bankruptcy, if any. The details such as bankruptcy filing and status, whether open or closed. Furthermore, these details stay in the credit report for a period of seven to ten years. The duration depends on the type of bankruptcy. Also, if there isn’t any relevant information, the section may not appear in the credit report.

What is the difference between a Credit Score, Credit Rating, and a Credit Report?

Credit rating is associated with a company or business. In other words, it determines the creditworthiness of a business or company. Hence, it does not apply to individuals. The ratings help to interpret the company’s ability to repay its debts. The credit ratings are denoted in symbols like AAA, AA, A, B, etc.

Furthermore, credit ratings are on the basis of corporate financial instruments. Hence, higher ratings imply a lower probability of default. AAA rating is considered to be a good rating. On the other hand, ratings below BB are considered as a bad credit rating.

Credit bureau calculates a number known as a credit score for an individual. A credit score is calculated for an individual based on their credit information report. To calculate the score, the bureau evaluates repayment behaviour and credit history of the individual. The score value ranges between 300 and 900. Also, the score is essential while applying for a loan. Lenders evaluate the individual’s credit score before approving credit to them.

Credit report records an individual’s past borrowings. In other words, it is a report card that lenders refer to before issuing credit to an individual. The report keeps a record of personal information, payments history, enquiries, etc. Simply put, it is a consolidation of an individual’s credit history. Credit information companies generate these reports for banks and other lending institutions. Banks and other lending institutions use these reports to grant credit, verify a person’s identity and for determining the credit score.

Who can access my credit score report?

Several organisations can access an individual’s credit score. If there is a legitimate business need by an organisation, then they can access a person’s score. Few of the organisations that can access a person’s credit score are:

  • Banks
  • Creditors
  • Loan providers
  • Insurance companies
  • Employers
  • Government agencies
  • And any entity with legal permission.

Do late payment of loans and credit card bills affect my credit score?

An individual’s loan repayment history affects their score the most. A credit bureau (credit information company) keeps a month on month record of all payments towards bills, and EMIs. A single non-payment or late payment of a loan or bill can pull down the score by 100 plus points.

What is a credit score enquiry?

A credit enquiry is a credit score check. In other words, it means to check a person’s creditworthiness. A credit enquiry happens when there is a legally permitted request from a company or individual to check the credit score of a person.

There are two types of enquiries: hard enquiry and a soft enquiry. A hard enquiry is made with the consent from the person whose score needs to be checked. Usually, when a person applies for a credit card or loan, the lender pulls the credit data of the borrower to assess his/her ability to repay. This is usually done with permission from the borrower.

A soft enquiry is not reflected in credit reports. Every time a person checks their score, a soft enquiry is raised. Soft enquiries are made by lenders when pre-approved loans are offered to individuals.

The credit bureaus record a hard enquiry. Too many hard enquiries in a short period might decrease a person’s credit score.

Frequently Asked Questions

Is a PAN card required to get a credit score?

Having a PAN card is not mandatory to check the score. One can get their credit score and credit report by providing other proofs of identity like voter ID number, license number or passport number.

Does credit score enquiry affect my credit score?

A hard enquiry made by the lender will affect the score. Too many hard enquiries within a short period will indicate a person’s creditworthiness is unstable. Hence too many hard enquiries will bring the score down. However, a soft enquiry will not reflect in the credit reports.

Is credit score important while applying for credit cards and loans?

Yes, having a good credit score is important while applying for loans and credit cards. A good credit score will help in getting faster approvals of loans and credit cards. Also, a bad credit score will lead to rejection of applied loans and credit cards.

Do holding multiple credit cards affect my credit score?

Credit cards come under unsecured loans. Having too many unsecured loans in one’s credit mix will reduce their credit score. Additionally, having too many credit cards might be difficult to manage. In case one misses to pay a credit card bill, then a late payment or non-payment of a bill might drag down the score by 100 plus points. Hence, it is advised that individuals limit their credit cards to 2 or max 3. This will help them in managing their credit better.

Published on October 9, 2020