The definition of credit is the practice of borrowing money, either as a loan or for purchase with the promise of paying off the debt within a stipulated period of time. A credit score is defined as a statistical method to ascertain the likelihood of an individual paying back the money that is owed to them.
A credit score is essentially used by lenders, physical or online, to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. It is used to determine who qualifies for a loan, the interest rate, and up to what credit limit. Organizations like mobile phone companies, landlords, and government departments also use the credit scores of individuals to ascertain their creditworthiness.
Need for Credit Score
Credit score is important to measure the risk assessment of an individual by the credit issuer. This is especially employed when an individual applies for credit like a loan, mortgage, or credit card. It allows the financial institution, which is extending the credit, to check the individual’s reliability in repaying the debt in a timely manner. A lower credit score can result in a loan rejection or even a higher interest rate compared to someone with a higher credit score. The credit score is valuable only when the data collected is over a long period of time.
Components of Credit Score
There are various factors taken into consideration when evaluating the credit scores of an individual. These factors all add up to either a high or low credit score.
- Credit payment history of the individual (35%)
- Current debts of the individual (30%)
- Duration of time of credit history (15%)
- Credit Mix (10%)
- Frequency of applications for new credits (10%)
Credit Scores Calculation
Credit Information Bureau (India) Limited (CIBIL), established in August 2000, is the first credit information company in India. It is CIBIL that allows credit ratings to individuals and sends them to banks for a loan applicants, based on which a loan is either sanctioned or not sanctioned.
It is a two-way information exchange where initially all credit information of an individual is sent to CIBIL by the banks. This information essentially pertains to the repayment of loans and credit cards. Information is then computed by CIBIL into a number range between 300 and 900. Scores lower than 600 and closer to 300 are considered low credit scores and may lead to applications for loans and credit cards being rejected. A credit score rating of higher than 600 ensures a higher possibility of getting a loan or credit card. CIBIL maintains a historical record of an individual’s payment behavior pattern which is sent to banks on request.
This service was launched with a view to reduce bad credits as well as to instil habits leading to high credit scores and teach financial planning to individuals.
How to Maintain a Good Credit Score?
A loan or credit card application may be rejected even if all other criteria like age and monthly income are met, due to a low credit score. A credit score of 750 or above is usually considered a good credit score. There are certain steps that an individual can take to ensure that he or she maintains a good credit score.
1. Payment on Time
Payments that are made on time indicate a responsible and healthy attitude towards credit, which helps in maintaining a good credit score. The opposite, in fact, may reflect a negligent attitude with poor financial planning and can have a negative impact on credit scores.
2. Apply for Only One Loan at a Time
Every time an individual applies for a loan, the banks check the applicant’s CIBIL score that lowers for every check that is triggered. This effectively lowers the overall credit score. The more loans an individual applies for, the lower the credit score.
3. Updated Credit Card Payments
Credit card bills can be paid either in full every month or can be kept active by paying the minimum amount that is indicated by the bank. However, CIBIL considers the unpaid amount as overdue which indicates poor personal financial management. This reflects in the individual’s history every time a check is triggered. It is always better to pay the credit card bill in full to maintain a healthy credit score.
4. Don’t Close Credit Cards
Simply put, if all credit cards are closed, there is no avenue to build a credit history to lean on when a loan is required. It is ideal to maintain at least one credit card and maintain a healthy repayment history with the card to build up a good credit score.
5. Refrain from Payment Defaults
If there is an existing loan on any credit cards, ensure that all payments are made on time. Any misses or default gets recorded in the credit history can negatively affect the credit score and may also result in a loan being rejected.
6. Manage Expenses within the Earnings
When the spending exceeds the earning, it gives rise to credit which can lead to more spending and thus a collection of debt. It is wise to spend within a limit that can be supported by the earning which also adds to the overall credit score.
7. Balance the Loan Types
It is a healthy habit to keep a mix of loans. The idea is to balance secured and unsecured loans. If the loans are heavier on the unsecured credit side, personal loans or credit card loans, it acts as a red flag and makes lenders cautious about granting further loans.
The importance of maintaining a healthy credit score cannot be ignored. It is a gateway to getting a home loan or a personal loan as and when required. A high credit score also helps an individual in getting credit cards that is also another way to build a healthy credit history, eventually making a positive impact on the overall credit score of an individual.
What is a good credit score in India?
A credit score of 750 and above is considered a good credit score in India.
Can I get a loan or credit card with a credit score of 500?
A credit score of 500 is considered to be a poor score, hence it is difficult to get approval for a loan or card with this score.
What is a CIBIL credit score?
CIBIL score is a three-digit numeric summary of your credit history.
What is the toughest credit score?
850 is considered to toughest credit score to achieve.