When you apply for a credit card or loan, the most important criterion that a lender checks is your credit score. A high credit score increases your chances of getting a new loan or credit card approved at favourable terms and conditions. However, if your credit score is low, lenders will deny you any loan or credit card. A credit score is nothing but your creditworthiness, which helps lenders decide whether to approve or reject your loan request.
What is a Credit Score?
A credit score is a three-digit number ranging between 300 and 900 points. Credit bureaus assign credit score numbers based on various factors such as loan repayment history, credit utilization, length of credit history, etc.
If you have a good credit score, which is generally above 750, it is considered the best credit score. Most lenders are comfortable giving loans and credit cards with a credit score of 750 or above because they are confident that you will repay your loan on time.
But if you have a poor credit score, it will be difficult to get any loans and credit cards. Even if any lender agrees, he will charge high interest rates on the loan.
Why do Lenders use Credit Scores?
When you apply for a new loan or credit card, lenders want to know your creditworthiness, whether you have paid your previous loans on time or not. A high credit score indicates that you always repay your dues on time, and your credit utilization ratio is also within the acceptable limit. If you have a low credit score, it indicates that either you have defaulted on payments in the past or your credit utilization ratio is above the acceptable limit. Lenders use your credit score to decide whether to approve or reject your loan.
Who calculates credit scores in India?
- TransUnion CIBIL (Credit Information Bureau India Limited)
- Equifax Credit Information Services Private Limited
- Experian Credit Information Company of India Limited
- CRIF High Mark Credit Information Services Private Limited
You can check your credit score from their website. There may be chances that your credit score as per one credit bureau may be different than other credit bureaus. The reason is that each bureau calculates your credit score independently based on the information provided by banks and financial institutions.
How Credit Score is calculated?
There are five important factors used to calculate your credit score.
Payment History
If you have a long history of paying your loan and credit card bills on time, it will have a positive impact on your credit score. Credit bureaus keep a month-by-month record of all your loan and EMI payments.
If you have not paid an EMI in the past or have delayed payments, it will reflect in your credit report and negatively impact your credit score. Hence, it is always advisable to pay your dues on time and never miss an EMI. Missing even a single EMI can lower your credit score by more than 60-100 points.
Credit Utilisation Ratio
Credit utilisation ratio means the ratio of the total credit amount you have utilised and the total credit limit available to you. For example, if your credit card limit is Rs 1,00,000 and you utilised Rs 70,000, your credit utilisation ratio is 70%.
The more you use your credit card, the higher your credit utilisation ratio will be. A higher utilisation ratio is not good for your credit score as a higher credit utilisation ratio is a sign of credit-hungry behaviour.
So, it is always advisable to keep your credit utilisation ratio below 30%. A credit utilisation ratio below 30% is a sign that you can handle your finances comfortably and that you are not overly dependent on your credit cards for your expenses.
If you are using your credit cards more frequently, ask your credit card providers to increase your credit limit. A higher credit limit will help you to reduce your credit card utilisation ratio, which will help in improving your credit score.
Duration of Credit History
A long history of timely payment of all your dues helps in improving your credit score. If you have old loans and old credit cards, do not close them even if you have made all your payments. Old loans & credit cards help lenders to make informed decisions whether to grant you a new loan or not.
If you have a long history of timely payment of all your dues, it improves your creditworthiness. It gives confidence to lenders that you will continue to repay all your dues on time in future as well.
Credit/Product Mix
A mix of secured and unsecured loans also affects your credit score. Taking multiple types of loans like home loans, car loans, and personal loans improves your credit score. However, if you have a higher proportion of unsecured loans, it will negatively impact your credit score. A higher proportion of unsecured loans reflect credit-hungry behaviour.
New Loan Inquiry
Whenever you apply for a new credit card or loan, lenders inquire about your credit score. The inquiries made by lenders are considered hard inquiries and hard inquiries decrease your credit score.
Whenever we apply for a new loan or credit card, lenders get our credit card reports from the credit bureau to re-evaluate our creditworthiness. So, instead of applying for loans from multiple banks, it is better to check your credit score by yourself. Checking your credit score by yourself is considered as soft inquiry and soft inquiry will not make any negative impact on your credit score.
After checking your credit score, check your loan or credit card eligibility online based on your credit score, income, requirements etc. By doing this, you can find out which bank/financial institution is ready to provide you loan or credit card and you can apply directly to that bank/financial institution. As a result, you are not required to apply to various banks/financial institutions.
What is the Credit Score Range?
A credit score is a three-digit number that represents your creditworthiness. A higher credit score i.e., 750 or more is considered good and is preferred by lenders for any loans and credit cards.
However, if you have a low credit score, it will be very difficult for you to get a loan or credit card. Even, if any lender approves your loan application, then the rate of interest on the loan will be higher.
Here is the range of Credit Scores and its meaning:
(a) 750 to 900 – Excellent – A credit score within this range is considered an excellent credit score. If you have a credit score in this range, then you will be offered loans at much lower rates and credit cards with much better rewards.
(b) 650 to 749 – Good – A credit score within this range is considered a good credit score. If you have a credit score within this range, then also you can get loans and credit cards. However, it will be very difficult to negotiate with lenders and the interest rate will be high.
(c) 500 to 649 – Average – A credit score within this range is considered an average credit score. If you have a credit score within this range, then it is almost impossible to get loans and credit cards. This credit score represents that borrowers may have defaulted in the past or have a high credit utilisation ratio. Lenders also consider scores within this range as unfavourable. You may get loans at this score but with a high interest rate.
(d) 300 to 499 – Poor – A credit score within this range is considered a poor credit score. If you have a credit score within this range, it represents that you had a bad credit history, such as missed payments, high credit utilisation ratio, loan defaults etc. If your credit score is within this range then you need to work on improving your credit score.
How to improve your credit score?
Improving your credit score is not a one-day job. It takes some time when you follow these steps regularly.
Check credit report regularly
Checking your credit report is one of the most critical tasks for improving your credit score. You may have a long history of timely repayment but there may be some errors that are negatively affecting your credit score. These errors could be incorrect personal information, incorrect account details, mismatches in credit accounts etc.
If you check your credit report regularly, then only you can identify these types of errors. Correcting these errors will increase your credit score.
Timely Payment
Timely payment of all your dues is the most important factor for calculating credit score. If you miss a single loan EMI payment or there is a delay in payment, it will significantly decrease your credit score. Therefore, it is very important to ensure that all the dues are paid on time.
The best way to repay all your dues on time is to set reminders for all your EMI payments and credit card dues. You can also add standing instructions to your bank account from which a fixed amount will get deducted on a regular period (mostly monthly).
Credit Utilisation Ratio
The credit utilisation ratio is also one of the most important factors used in calculating your credit score. A higher credit utilisation ratio represents you as a credit-hungry person. So, always try to keep your credit utilisation ratio below 30%.
If your credit utilisation ratio is continuously higher, then you need to request your lenders to increase your credit card limit. A higher credit card limit will help you to improve your credit utilisation ratio. Sometimes, credit card providers themselves offer to increase the credit limit depending upon the behaviour of credit card users.
A higher credit card limit doesn’t mean you need to spend more. It only means that a credit card gives you the flexibility to spend more money when required. A higher credit card limit and lower spending will result in lower credit card utilisation.
Multiple Credit Application
When you apply for a loan or credit card, lenders inquire about your credit score from credit bureaus. When lenders inquire about your credit score, it is considered a hard inquiry. Hard inquiry decreases your credit score.
When you apply for loans to various banks/financial institutions, they all inquire about your credit scores. Multiple such hard inquiries within a short period can negatively impact your credit score. It shows that the borrower is credit-hungry and his financial condition is not so good, which is why he is applying for loans to different lenders so desperately. As a result, the borrower is considered a high credit risk and it is believed that he will not be able to repay his dues in future.
Hence, if you need any loan or credit card, do proper research, compare different options available and then apply to one lender. This will help you in avoiding multiple loan applications.
Mix of Credit
Having different types of loans such as personal loans, home loans, car loans etc., increases your credit score. A mixture of secured and unsecured loans with timely repayment gives confidence to lenders that the borrower can manage the different types of loans effectively.
Improving your credit score takes time. You need to continuously work on improving your credit score.
Why my credit score is declining?
Even if you are paying your dues on time, there can still be cases where your credit score is going down. A credit score is one of the most important factors in assessing your creditworthiness. Hence, a drop in your credit score will impact your creditworthiness negatively.
There can be multiple reasons that your credit score is declining. Here is a list of some of them.
Credit Utilisation Ratio
A credit utilization ratio is one of the most important factors in calculating your credit score. Always keep your credit utilization ratio below 30% of your credit limit.
You may have recently made a high-value purchase on your credit card that has increased your credit utilization ratio.
In this case, try making payments on your credit card before your next billing cycle. If you make enough payments before your billing cycle, your credit utilization ratio will come below the acceptable limit.
If your credit utilisation ratio is continuously higher, then you need to request your lenders to increase your credit card limit. A higher credit card limit will help you to improve your credit utilisation ratio.
You applied for a new credit card or loan
When you apply for a new credit card or loan, lenders make hard inquiries about your credit score. These hard inquiries made by lenders lower your credit score slightly. However, if hard inquiries are made multiple times in a short period, it will lower your credit score significantly.
Applying for a new credit card or loan in a short period is very harmful to your credit score. When you apply to multiple lenders in a short period, it looks like you are a credit-hungry person and you are in dire need of money.
Lenders think that credit-hungry individuals cannot manage their finances effectively and are more likely to default.
Check your credit report
It is also possible that there is an error in your credit report that you are not aware of and that error is causing your credit score to go down.
There may also be cases where someone else’s credit activity is being recorded in your credit report due to an error. It is also possible that someone else is applying for a credit card or loan in your name.
In such a case, report this error to the credit bureau to correct it. Therefore, it is always advisable to check your credit report regularly. If you notice any error in your credit report, report it to the credit bureau immediately. Correcting your credit report will significantly improve your credit score.
Missed or Late Payment
Paying all dues on time is the most important criterion for calculating your credit score. Missing even a single EMI or paying your loan late can lower your credit score significantly. The worst part is that these missed payments and late payment details remain in your credit score for 5 to 7 years.
Final Thoughts
I hope this post helped you understand about credit score.
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