Credit Scores and their Significance

Importance of Good Credit Score

• A higher credit score offers your lender the idea that you are a low-risk borrower. It is critical if you wish to obtain a larger loan amount.
• You can get a low-interest loan if you have a good credit score. Furthermore, it can help you get longer repayment terms.
• If you are in a pinch for cash, your credit score can help you gain immediate approval in a matter of minutes.
• A good credit score further allows you to apply for different forms of loan at the same time without any fear of rejection.

The higher your credit score, the easier it will be for you to obtain a loan. Your credit score is determined after analyzing various factors. A few prominent factors are described as follows:

Factors Influencing Your Credit Score

1. Re-payment History

Past records of loan re-payment are a very critical parameter for assessing your credit borrowing history. NBFCs and lenders pay special attention to this aspect, and timely payments result in a higher score, which, in turn, leads to quicker and hassle-free approvals for new loans. 
 

2. Outstanding Debts

NBFCs and lenders take un-serviced debts very seriously. Your credit score could take a major hit from a high amount of un-serviced loans in your name, as it signals an inability to repay debts such as unpaid loans, overdue credit card bills, and loan EMI's.
 

3. Duration of Credit History

It takes some time to build a satisfactory credit history which clearly demonstrates good financial management. This time frame could range from a few months to a few years, depending upon your credit mix, utilization, repayment patterns, and other factors.
 

4. Credit Mix

Credit scores are also affected by the mix of various credit products that you are using. A balanced mix is favourable over an excess of one type of debt. There are a few types of financial transactions which usually don't affect your credit score, such as phone bills, rental payments, and payment of insurance premiums.
 

5. Credit utilisation ratio

The credit utilisation ratio shows how much of your available credit limit you have utilised. The ratio is determined by dividing the amount of credit you have consumed by your total credit limit. The ratio informs lenders and credit bureaus about how credit-hungry you are. It also tells them about your spending habits. For example, a larger credit utilisation ratio indicates that you are spending beyond your means.
 

6. New credit line

Every time you apply for a new line of credit, such as a personal loan or credit card, the financial institution conducts a hard inquiry, also known as a hard pull. The hard enquiry is reported on your credit report. Multiple loan applications or the opening of too many credit accounts gives financial institutions the impression that you are unable to meet your basic financial obligations and you aren't good at managing finances. In such a scenario, your loan application may even be rejected by the financial institution.
 
On the other hand, soft inquiries are made when a financial institution decides to increase your credit limit or when you want to verify your own credit score. It is also when lenders prepare a list of candidates for pre-approved loan offers and check if you qualify for the offer.
 
Soft inquiries do not impact your credit score but hard inquiries do. 
 

How to check your credit score

Credit Information Bureau of India (CIBIL), now known as CIBIL TransUnion, is a credit scoring agency that helps determine your credit score and ways to improve a low or less than favourable credit score. They maintain individual finance data for a period of 7 years. You can check this score online or when submitting a loan application. Other prominent credit information companies include Experian, Equifax, and High Mark. Having a good credit score is essential as it will help you get the best deals on credit cards and loans. You can even negotiate better interest rates and repayment options with your lenders.
 

Why do you have a Low Credit Score?

As discussed earlier, there are a lot of factors affecting your credit score. However, even if you are taking corrective action, then you should look at the following reasons for why your credit score is not improving:
 

1. Mismanaged credit card bills

If you cross about 30% of your credit limit, chances are that it will result in a lower credit score. Accumulated or late credit card payments are valid grounds for a reduced credit score.
 

2. Unsettled dispute with a credit card or loan company

The term 'settled' has negative connotations. It could mean that the lending company or credit card company had to forego some part of their payment because you weren't able to repay on time. As this can adversely affect your credit score, ensure that all debts availed by you are fully paid.
 

3. Reporting error

Sometimes, the credit report may have a few errors. An error as small as a spelling mistake in your name can change your credit score and history. Read your credit report thoroughly and use the dispute resolution mechanism for closing any reporting error.
 

4. Making frequent minimum payments

Paying on time is great but scraping by with frequent minimum payments is not seen positively. Working towards paying off debt takes time, effort, and commitment.
A good credit score can help secure quick approvals on your loan and mortgage application for personal and business uses.

Some Quick Ways to Improve Your Credit Scores

1. Pay your credit card bills and loan EMIs on time

These payments will have a direct impact on your credit scores. Make sure that you stick to the schedule and make these payments in full and on time. Missing a payment or making a late payment is highly unadvisable.
 

2. Credit card utilization

Try and keep your card utilization rate below 30% as this would improve your credit score.
 

3. Secured >3. Secured & unsecured debtamp; unsecured debt

A healthy mix of secured & unsecured debt helps ramp up your credit score. For example, credit cards are unsecured debt while car loans are secured debt.
 

4. Close out loans where relatively small amounts are left

Your credit score will also depend on how long it takes you to repay a loan. Close out all outstanding debt before you go for a loan as it will reflect well in your credit score.
 

5. Monitor your credit report

You must check your credit report at least once a year. It will help you in identifying any omissions, inconsistencies, and mistakes early. If you discover any inaccuracies in your report, make an immediate effort to correct them. Depending on the situation, you may either contact your existing or previous lender or write directly to the credit bureaus with supporting documents. 
 
For example, contact your previous lender if you discover an unpaid loan that you have already paid off on your credit report. You must request the lender to send a loan closure report to the credit bureau. You may also draft a rectification email and send it to the credit bureau, along with a no-objection certificate (NOC) and your permanent account number (PAN) card copy.


Also Read: Can A Personal Loan Help You Improve Your Credit Score
 

1. Increase your card limit

   If you have a good credit score but plan to use your credit card more frequently in the upcoming months, you must raise your card limit. It will allow you to meet your financial requirements without worrying much about the 30% credit utilisation limit.  
   A good credit score is essential because it allows quicker and cheaper access to funds. Make sure you follow the steps outlined above to maintain a good credit score. Apart from that, make sure the company you are working for has a decent market reputation. Furthermore, don't use up all the funds in your bank account because financial institutions will want to check your most recent bank statements to get an insight about your spending habits.
    

Disclaimer: This post was first published on 18th August 2017 and has been updated for the latest information, freshness, and accuracy.