Credit bureaus simplify the process of calculating your creditworthiness
Credit-worthiness. This term has been nothing less than a revolution in the Indian financial sector for the past decade. You may have come across tons of information and advice about the importance and role of creditworthiness in our financial lives. This is even more true if you have taken out or applied for a loan or credit card. But in the midst of the deluge of information that we are overwhelmed with in credit counseling, one less touched-up aspect is how credit bureaus actually calculate your creditworthiness.
And when the New Year 2022 knocks on our door, isn’t it the time to understand this crucial aspect of your financial life? After all, a credit rating has the potential to increase or destroy your chances of getting credit and credit cards approved.
So read on as we help clear the air around the concept of creditworthiness and make it easier for credit reporting agencies to calculate your creditworthiness.
What is a Credit Score?
A credit score is a three digit numeric representation of your credit history and is generally between 300 and 900. It shows how well you have handled your debt repayments based on your past repayment history towards your credit EMIs Credit card Bills.
Also Read: Worth Explains – Why Credit Should Be A Millennial’s Best Financial Partner
How do credit bureaus calculate your credit score?
Your creditworthiness is calculated by credit reporting agencies based on the information in your credit reportwhich, in addition to other credit-related information, also includes a summary of your current credit outstanding, past credit accounts, and existing credit card balances.
There are currently 4 credit bureaus in India – CIBIL, Equifax, Experian and Crif Highmark. Although each of these four credit bureaus has its own rating parameters and mechanisms for calculating creditworthiness and weighting the parameters involved, the key factors that are considered by the credit bureaus include the credit repayment history of loans and credit cards, credit mix, credit utilization rate, age of the credit history and credit inquiries .
Let’s dive deep and understand these factors.
1. Payback history of credit card bills and credit EMIs
It is widely believed that the repayment of your credit card bills and credit EMIs from the bureaus have a significant weight in calculating your credit score. Paying back your credit card bills and credit EMIs in a timely and full manner helps build a cheap credit history that gradually builds into a strong credit score.
On the other hand, credit card and loan repayment irregularities can affect your creditworthiness as doing so will portray you as financially undisciplined.
In addition, the loan accounts that you co-signed / guaranteed will be included in your credit report for the calculation of creditworthiness, since by co-signing / guarantee you are equally liable for the timely repayment of this loan. So if the main borrower were to delay or default, your creditworthiness would be affected along with that of the main borrower. For this reason, it is advisable to regularly review the repayment activity of your co-signed or guaranteed credit accounts and ensure on-time payments to prevent it from affecting your creditworthiness and future creditworthiness.
Also read: Why do millennials fall into the credit card debt trap?
2. Credit mix
The credit mix is the ratio of your unsecured (like personal loans and credit cards) to secured debt (like home loans and car loans). Since lenders tend to prefer loans to those who have a balanced mix of secured and unsecured loans in their portfolios, credit bureaus also tend to rate such borrowers higher and cheaper. Whereas those with too many unsecured loans can be perceived negatively by the Schufa and lenders, which can also damage creditworthiness.
3. Loan Utilization Rate
This ratio is the percentage of your total credit card limit that you have used. For example, if you have a total credit limit of ₹ 1.5 lakh and your current outstanding credit card charges are 75.0.0, your CUR is 50%. Note that lenders generally view a credit utilization rate above 30% as a sign of credit hunger, which can be viewed as a higher probability of default on future loan repayments. As a result, credit bureaus also have a tendency to drop your credit score by a few points if it exceeds that 30% mark, which can do significant damage to your credit score, especially if it happens frequently.
4. Credit Inquiries
Every time you submit a credit or credit card application, the lender collects your credit report from the credit bureaus to assess your creditworthiness and your repayment history to date. Such lender-initiated credit report inquiries are listed on your credit report as credit inquiries, each of which can reduce your creditworthiness by a few points. And, if you end up submitting multiple loan applications to lenders, especially in a short amount of time, your credit score can go down.
Hence, it is better to spread your applications out over different time periods so as not to bombard lenders with too many applications and also try to research the eligibility and offers of different lenders and then focus on sending applications to only the most promising ones .
5. Age of credit history
Another factor that credit bureaus often consider when calculating your credit score is the age / length of your credit history. In general, the longer your credit history, the better your creditworthiness, as lenders and bureaus have a longer view of your loan repayment history. Credit bureaus usually take into account the age of your oldest form of credit, be it a loan or a credit card. For example, you took out your first loan or credit card 5 years ago so the age of your credit history would be 5 years.
Also read: Why your creditworthiness can go down despite on-time payments!
How can you check your credit score?
There are two ways to check your creditworthiness. You can either get your credit report directly from the credit reporting agency’s website or download it from online financial institutions and / or portals / apps that offer the option to download your credit report for free.
Because credit reporting agencies are required to provide customers with a free credit report at least once a year, ideally you should distribute your credit report inquiries so that you have offices available from the 4th of each quarter of the year.
Alternatively, some online financial marketplaces also offer the option of generating free credit scores and credit reports each month.
Also Read: Tick This 5 Point Checklist Before Applying For A Loan
How does credit score affect your credit and credit card approval chances?
A credit score is used as one of the first filters lenders consider when evaluating your credit and credit card applications. It helps the lender, be it a bank, NBFC, or fintech, to assess your creditworthiness based on past repayment history, which also indicates the likelihood of future credit / credit card repayment default.
Good credit will make you more trustworthy, while low or no credit (no credit history meaning you have not yet taken out a credit card or loan) would cause the lender to be cautious in deciding whether to accept or accept the loan reject your request.
With all that being said, the role of creditworthiness has gradually expanded to also be the foundation for lenders to set your loan rates as part of risk-based pricing. In this practice, those with higher credit scores are likely to get a cheaper loan to someone who has poor or even no credit.
Is your credit or credit card application being declined with a low or no credit score?
Although financial institutions generally prefer loans to applicants with a credit score of 750 and above, low or no credit scores are not always a dead endbecause they may be offered loans at relatively higher interest rates than applicants with high creditworthiness. This higher interest rate is calculated to cover the existence of a higher credit risk, ie the risk of default on those with low or no creditworthiness. However, the final decision rests with the lender after considering not only creditworthiness but also other aspects such as income, loan amount, age, existing debt, etc.
Also read: 5 super financial resolutions for the new year 2022
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