Need for Credit Score
When lenders offer loans to borrowers they have to ascertain the veracity of claims made by borrowers of their earnings and other credentials. It becomes difficult for lenders to check the authenticity of the claims made. This assumes humongous proportions when thousands of borrowers apply for various types of loans.
In order to streamline the process of loan applications and evaluation of the same, lenders seek a variety of documents to support the information provided on the application. These could include
- KYC documents that prove the identity and address – PAN card, Aadhaar, Address proof,
- Income tax return (ITR) documents
- Bank statements
- Employment documents
- Registration of business documents
- Financial statements – balance sheet and profit and loss (P&L) accounts
- Credit score
While most of the documents sought are Government Issued documents as well as documents submitted to statutory authorities, the credit score is a number issued by a credit bureau.
What is a credit score?
A credit score is a credit rating score issued by a credit bureau. TransUnion CIBIL (CIBIL) is a credit bureau that provides creditworthiness rating of borrowers through a CIBIL score.
CIBIL has a membership of more than 2,400 companies operating in the finance industry. These companies offer loans to more than 550 million customers in India. CIBIL receives data on these customers from the lenders. CIBIL analyzes the data and comes up with a score known as the CIBIL score for each individual borrower.
CIBIL tracks the repayment record of each borrower in respect of loans taken by the borrower. If the repayment history of the borrower is perfect with all EMIs paid on time without default, the borrower gets a score of 900, which is the highest. If the repayment history of the borrower is imperfect with too many defaults and late payments, the borrower gets a score of 300, which is the lowest. The repayment history of borrowers falls within these two outside limits – 300 to 900. Typically, lenders consider borrowers with a score of 750 and above as very safe and extend the best terms to such applicants when they apply for a loan.
CIBIL also offers a personal loan credit score – a credit score purely based on personal loans availed by borrowers. This score helps lenders to become more circumspect when granting personal loans.
Use of Credit Score
Lenders depend on credit score besides the other supporting documents to determine the terms and conditions of a loan. In the case of secured loans, the lenders have an asset to fall back upon in the event of default. In the case of unsecured loans such as personal loans, lenders depend on credit score as the most important criterion to decide the terms of the loan. Typically, a good credit score of 750 and above gets the borrower the lowest interest possible and the highest tenure and the largest amount of loan.
How borrowers can boost their credit score
It is important for borrowers to ensure their credit score is high. Of course, if borrowers are extremely prompt in repaying all their loans without a single default, they need not worry as they earn a high credit score and therefore command good terms from lenders.
Are there ways to improve credit score? Yes, there are ways to improve credit score and they include
Understand mechanics of determining a credit score
It makes good sense to understand the process of determining the credit score by credit bureaus. If you understand the process then it is easier to plan your activities so that you can attain a high credit score.
Buy Credit report and take action to correct anomalies
Invest a small amount and obtain your credit score from CIBIL. Study the report thoroughly to understand your credit history. You can then take corrective actions wherever required. You need to take corrective actions if you find any discrepancies as otherwise they get reflected in your credit score. Pay particular attention to closed loans – they should reflect as closed. If not, it affects your credit score.
Be prudent in your borrowings
With so many avenues available for borrowing – different types of loans, credit cards and EMI options from sellers it is tempting to go for more loans. It is always better to limit your borrowings to the bare minimum and in any case, you should not borrow more than what you can repay.
Pay off all dues on time
Limit your credit cards to 2 or 3 and use them sparingly ensuring you pay off the full amount due and not the minimum amount due. Avail the maximum benefit offered by credit cards – up to 53 days of credit without charges. Pay all your EMIs on other loans promptly without any defaults.
Maximize secured loans
It is better to avail more secured loans than personal loans. But, more importantly, you must pay the EMIs regularly without default. Since secured loans are long-term loans, a good repayment history builds your case for a good credit score.
Treat credit cards with kid gloves
Credit cards are a boon if handled properly or a bane if handled poorly. They harm your credit score if you become greedy and misuse their benefits. If you have many credit cards it helps because your credit limit is high. This works to your advantage if you are meticulous in paying the full amount due. If you pay only the minimum amount due, then it works against your credit score because your available credit limit comes down. So, make credit cards your friend by using them judiciously and ensuring to pay off dues promptly and fully.
Prudence in handling your financial affairs will go a long way in enhancing your credit score enabling you to have access to funds when you need the most without any hassles.