We all have heard of the term credit score or CIBIL score and how a good score is important to avail a loan from any financial service provider. In this article, we will help you to understand below aspects of credit score amongst many other things
- What is a credit score or CIBIL score?
- What is a good score?
- How is it usually calculated?
- Why is it important to avail a loan?
- What can one do to improve the score?
What is a credit score or CIBIL score?
A credit score is a 3-digit number provided by approved credit bureaus which reflect the credit worthiness of an individual. CIBIL score is also a credit score provided by Credit Information Bureau India Limited (CIBIL), which is one of the four bureaus licensed by Reserve Bank of India to provide individual’s credit scores. The other three bureaus are
- CRIF High Mark
- Experian
- Equifax
Credit scores provided by these different bureaus can vary as they can use different parameters to assess individual’s credit worthiness.
What is a good credit score?
Credit score usually ranges between 300 and 900. In layman’s term, score closer to 900 is good and score closer to 300 is bad. But what score is considered good by financial institution for granting a loan is of more importance.
For availing a loan, a score between 700 and 900 is normally considered good by most of the financial institution wherein a score between 300 and 500 is normally considered bad. Credit score is nothing, but a reflection of credit history and higher credit score denotes that financial institutions will find the individual creditworthy.
How is it calculated?
Every credit bureau has its own specific parameters to arrive at the credit score. These bureaus do not disclose these parameters in public and guard them as trade secrets. However, there are few factors which are considered critical to calculate the score
- Repayment history – this is considered the most important factor in calculating the credit score and contributes to about 35% of the score
- Credit utilization ratio – the second most important factor is the usage of credit limit granted to the individual. Higher utilization of sanctioned credit limit can hamper the credit score and this factor contributes to about 30% of the score
- Duration of credit history – average duration of all credit accounts (loans, cards etc.) contributes to about 15% of the credit score. Longer the credit history is, higher the credit score is likely to be
- Type of availed loans – mix of loan types (secured and unsecured) accounts for 10% of the credit score
- New loans and new loan enquiries – number of new loans availed or new loan eligibility check (hard enquiries by lenders) account for about 10% of the credit score. Too many new loans or hard enquires can reduce the score
Why is it important to avail a loan?
As explained till now, credit scores help lenders understand how good and responsible individuals are in handling debt. A good (high) credit score means less likelihood of defaulting on loan repayment and hence lenders may find it comfortable to grant a new loan. A high credit score also means better deals for individual in terms of loan amount, fees and interest rates. Lenders usually charge more to individuals with lower scores and may not offer loan at all to individual with very low score.
What can one do to improve the score?
It is important to take care of the factors which are considered critical to calculate credit score. Just follow the below mentioned simple rules and your score will start improving month-on-month
- Pay EMIs on time
- Limit usage of available credit limits
- Avoid applying for loans with multiple lenders
- Consolidate your loans
- Choose shorter loan terms