Access to credit via personal loans and credit cards is important to meet various needs relating to household, education, medical expenses, among others. In order to continue accessing credit, the borrower must understand the primary factor used by lenders for decision making – their Credit Score.
What is Credit Score?
In simple terms, your credit score is a numerical representation of your creditworthiness. It is a three-digit number that quantifies your credit history and provides lenders with an assessment of your likelihood of repaying borrowed money.
Credit scores typically range from 300 to 900, with higher scores indicating higher creditworthiness. These scores are not produced by lenders (e.g. banks or NBFCs) but rather by Credit Information Companies (CICs), that are licensed and regulated by the Reserve Bank of India to collect, maintain, and provide credit information to lenders. There are four CICs operating in India:
- TransUnion CIBIL
- Experian
- Equifax
- CRIF High Mark
Data collected by them covers various aspects of your borrowing and repayment behaviour, including:
- Loan and credit card account details
- Payment history
- Outstanding balances
- Credit limits
- Credit utilization ratios
- Loan tenures
- Account opening and closing dates
Why Your Credit Score Matters
As digitization increases, your credit score becomes critical to your financial life. More importantly, given that personal loans and credit cards are not backed by any collateral (asset), lenders mostly rely on the borrower’s credit score. As a result, it serves as a primary indicator of borrower’s repayment capacity and creditworthiness.
A superior credit score significantly increases the chances of getting approved for a personal loan and/or credit card. Other advantages can include a lower interest rate on personal loans, access to premium credit cards, enhanced limits, and others.
Below are general levels regarding credit score:
- 750 and above is considered Excellent
- 700-749 is considered Good
- 650-699 is considered Fair. Improving your credit score will likely increase your credit limits
- Below 650 is considered Poor. Improving your credit score is important if you fall within this range
Key Pillars of Credit Score
Let us now understand the key factors that impact your credit score particularly for personal loans and credit cards.
- Payment History: This is a key factor as lenders place the greatest emphasis on your track record of making payments on time and in full. Lenders are required to provide CICs with detailed information about borrower’s payment history, including any instances of late payments or defaults.
- Credit Utilization Ratios: This factor is particularly relevant for credit cards and represents the amount of credit you are presently using compared to your total available credit limit across all your credit cards. For example, if you have two credit cards with a combined credit limit of ₹2,00,000 and your total outstanding balance across both cards is ₹50,000, your credit utilization ratio would be 25% (₹50,000/₹2,00,000).
- Length of Credit History: Borrowers with a longer credit history are considered more reliable and predictable by lenders. A longer credit history provides more information to assess borrowing and repayment behaviour over time.
- Credit Mix: Having a healthy mix of different types of credit products can also positively influence your credit score. For example, if you have a personal loan that you are repaying on time, along with a credit card that you use responsibly and pay off regularly, this demonstrates that you can handle both instalment loans and revolving credit.
- Credit Inquiries for new loans/credit cards: Applying for new credit, whether it's a personal loan or a credit card, triggers a ‘hard inquiry’ on your credit report. While a single hard inquiry typically has minimal impact on your credit score, applying for multiple loans or credit cards in a short time can raise red flags for lenders and may lower your score.
For individuals, understanding that their credit score is not a static, fixed number is crucial. It is a dynamic number that can change over time as your credit behaviour evolves. Every time you make a payment, use your credit card, or apply for new credit, the information is updated in your credit report, and your score may be recalculated.
To check your credit score without any charge, click here.