In India, the demand for credit options such as credit cards, small-ticket loans and longer-term loans is gradually rising as opposed to the traditional practice of using readily available cash. In order to obtain a loan or any other credit product, lenders assess the borrower's credit score. It is therefore important to understand what a credit score is and the significance of maintaining a good credit score.
What is a credit score?
A credit score is a numerical value, usually consisting of three digits, that indicates an individual's creditworthiness. The score ranges from 300 to 900, with 900 being the highest score. When applying for a loan, banks and other regulated lending institutions typically assess an individual’s credit score. The score reflects the borrower's financial reliability and the probability of loan default. The credit score affects the loan amount approved and the interest rate applicable to the borrower. If an individual has a low credit score, they are considered to be at a higher risk of defaulting, which may lead to loan rejection or higher interest rates charged to them. On the other hand, a credit score above 750 is generally considered a good credit score. A healthy credit score is necessary for a hassle-free credit experience. Therefore, it is crucial to understand credit management and cultivate a positive credit history.
Currently, there are four credit bureaus in India that generate credit scores for individuals and businesses, evaluating various parameters such as outstanding debts, repayment history, loan tenures, credit mix and debt-to-income ratios. They are TransUnion CIBIL, Experian, CRIF High Mark, and Equifax.
How to find out your credit score?
Discovering your credit score is a simple process. Once a year, you can obtain your credit report from all four credit bureaus mentioned above at no cost. This can be done conveniently online by providing your basic information and identification details, such as PAN card, Voter's ID number, or Aadhaar card. The credit report will also include information on your previous credit usage, loans taken and their repayments.
Benefits of a good credit score:
1. Eligibility for attractive credit options:
Having a healthy credit score indicates that you are a trustworthy borrower, making you a desirable customer for lenders. Maintaining a good credit score can result in attractive credit card and loan offers, such as lower interest rates, longer repayment terms and faster loan approvals. This can lead to significant cost savings and a smoother borrowing experience.
2. Eligibility for higher credit limits:
Consistently paying existing debts on time can lead to an increase in credit limits, allowing you to access larger loans for longer durations. This may also result in faster approvals for higher limit loans.
3. Better bargaining power:
A good credit score is achieved by managing credit responsibly. Lenders seek borrowers who are unlikely to default and a healthy credit history indicates that a borrower is a reliable candidate. With a good credit score, you can negotiate credit terms and potentially secure favorable deals with lenders.
4. Sign of financial soundness:
A healthy credit score can serve as an indicator of an individual's overall financial stability. It reflects positively on an individual's financial standing and can potentially lead to various benefits. For instance, some insurers may waive certain document requirements for customers with good credit scores.
How can you maintain a healthy credit score?
Having a higher credit score can make you eligible for the most attractive loan offers, with lower interest rates. However, these standards may vary across different lenders. A few key habits you should adopt to ensure that you continue to maintain a healthy credit score are discussed below:
1. Ensure timely payments of EMIs and credit card dues:
One of the simplest yet crucial ways to manage your credit score is to pay your loan equated monthly instalments (EMIs) on time. This includes EMIs on various loans like home loan, car loan or personal loan, which play a vital role in maintaining your creditworthiness. It is important to keep a track of your due dates and ensure that your bank account has sufficient funds to avoid late charges and interest. Keep in mind that although your lender may not report a missed payment to the credit bureau immediately, a payment that is 30-days late or more can negatively affect your credit score.
During times of financial crisis, paying credit card bills may not be a priority for some people. However, it's important to pay at least the minimum amount due on your credit card to maintain a good credit score. If you're unable to pay the full amount, contact your credit card company and ask if they can help you restructure your payments so that the amount goes towards the principal balance, minus any fees and interest.
Your credit behavior plays a critical role in determining your financial well-being and each financial activity is assessed while calculating your credit score. Therefore, it is crucial to make timely EMI payments and clear your dues appropriately. By avoiding late payments, defaults and short payments, you can improve your credit scores and enhance your credit history. This will reflect positively on lenders, assuring them that you are a responsible borrower who is likely to handle future debts with greater responsibility.
2. Keep the credit utilisation ratio (CUR) within 30 percent:
The Credit Utilization Ratio is the ratio of an individual's credit limit to their credit spending. It is a crucial factor that affects credit scores after credit history. It reflects your credit usage in proportion to your credit limit. It is recommended to maintain a ratio of 30% or less to avoid any negative impact on your credit score. You can achieve this by practising restraint and avoiding overspending on your credit card. It's advisable to avoid maxing out your credit card limit every month. When your credit utilization ratio (CUR) exceeds 30%, lenders may interpret it as a sign of excessive credit dependence and credit bureaus may lower your credit score by a few points. Therefore, a high ratio can negatively impact credit scores, while keeping credit limit in check and using credit wisely can prevent exceeding the limit and help maintain a good credit score.
3. Avoid placing multiple credit requests within a short period:
When you apply for a loan or credit card, the lender obtains your credit report from a credit bureau to evaluate your creditworthiness. These requests, known as hard inquiries, can lower your credit score by a few points each time as this may indicate an excessive reliance on credit. Therefore, submitting multiple loan or credit card applications within a brief period can lead to a significant and rapid decrease in your credit score. Instead, prioritize your needs and take out loans one at a time. This will help you to maintain a high credit score.
Rather than directly approaching multiple lenders for credit, you could visit online financial marketplaces to compare various credit card and loan offers based on your credit score, income and eligibility criteria. In this scenario, these marketplaces retrieve credit reports while presenting credit options, but these requests are regarded as soft inquiries by credit bureaus. Thus, applying for credit cards or loans through soft inquiries will not have an adverse effect on your credit score.
4. Review your credit report at regular intervals:
Credit bureaus use information provided by lenders to calculate credit scores. However, mistakes or fraudulent credit transactions can lead to incorrect information being listed on credit reports, which can negatively affect credit scores. To identify such errors, it is essential to obtain and review your credit reports regularly. You should therefore request your credit reports from credit bureaus at least once a year. Alternatively, you can use online financial marketplaces to obtain their credit reports and monthly updates for free. By keeping a close eye on your scores, you can detect any changes and take appropriate corrective action. Additionally, it can help you track your credit usage and detect any suspicious activity, such as unknown transactions.
5. Check your eligibility for every new credit you take on:
Give that the loan market has expanded with numerous financial institutions offering loans, when seeking credit, it is important to avoid applying for loans in a random manner. Instead, check your eligibility for every new loan you plan to borrow. This will help you choose a loan option that is more likely to be approved.
It's important to keep track of your credit score, especially if you have recently taken on new debt and it’s advisable to obtain a new report to check for any changes to your credit score. If you notice any discrepancies or errors, it's crucial to report them to the credit bureau promptly to correct them as soon as possible.
6. Avoid terminating or modifying long-standing credit card accounts:
If you have old credit cards, it's important to keep them active and maintain a good payment record by paying the bills in full and on time. Cancelling these old credit cards may not be a good idea, especially if you've been a customer with a particular card issuer for a long time and have been making timely bill payments as they can contribute to a better credit score by showing a longer credit history.
Maintaining a long credit lifecycle can thus be a positive reflection of an individual's credit management abilities and lenders tend to closely consider their credit history. Building a strong payment record with a long-standing credit card can significantly impact credit scores positively. However, if there have been any irregular payments in the past, it is crucial to plan and avoid such instances to improve credit scores over time.
7. Comprehend the credit score risk:
To improve your credit score in the long run, it's essential to understand the risk factors that lenders consider when evaluating your creditworthiness. Factors such as payment history, amount of debt owed, duration of credit, new credit inquiries and the types of credit utilized are taken into consideration.
8. Only take on loans that you can repay:
Before availing of credit, it is important to carefully consider your repayment capacity and the necessity of the loan. Although there may be many tempting loan options and discounts available during sales, it is important to avoid taking on too many loans or making large purchases with down payments from yearly bonuses. While this strategy may work for some individuals, it can lead to missed EMIs and negatively impact your credit scores.
What Is a Good Credit Score for a Mortgage?
When you apply for a home loan, your credit score and credit history are evaluated by the bank. A credit score of 750 or higher is considered ideal for a home loan. This score enables you to negotiate better loan terms and may lead to lower interest rates, longer repayment periods and satisfactory housing finance. With a credit score between 650 and 749, you have a good chance of getting approved for a home loan, as lenders will review your other financial details. However, a minimum score of 650 is required by most lenders.
What Is a Good Credit Score for a Car Loan?
When applying for a car loan, you should consider several factors such as the principal amount, loan tenure, EMI, interest rate, registration cost, insurance and car accessories. Before applying, it is important to check your credit score and avoid having too many loans within a short period to increase your chances of approval.
Loan tenure plays a crucial role in determining your EMI and the interest charges you will have to pay. For instance, a five-year tenure will have a lower EMI compared to a two-year tenure but with additional interest charges.
An ideal credit score for car loans is 750 or above, as it offers higher approval rates and lower interest rates. Score above 750 makes the application process easy, giving you negotiating power and additional benefits such as zero down payment and low processing charges. Exceptional credit scores might even qualify you for substantial financing of the on-road price of the car.
Credit scores between 600-749 are average and can still be approved, although lenders may cross-check your income, ongoing loans and employment stability. The approval process might take longer and interest rates may not match your desired expectations.
Scores below 600 are considered low and the chances of approval are minimal. In most cases, these applications are rejected and even if approved, the loan amount will be low, with higher interest rates and the security of fixed deposits or assets.
What Is a Good Credit Score for a Credit Card?
When applying for a credit card, banks evaluate your credit score to determine your creditworthiness. Since it is a form of unsecured lending, banks want to avoid granting credit to risky customers. Your credit score helps them understand your repayment behaviour and how you utilize the available credit limit.
A credit score of 750 can result in a smooth application process and additional benefits such as lower interest rates, higher credit limit, eligibility for top credit cards and negotiation power. A credit score between 700-750 can also be approved based on other factors such as income and repayment of outstanding loans. However, a score less than 700 is unlikely to be approved and if it is, the bank may only offer a secured credit card against a fixed deposit.
Conclusion
Your credit score is a crucial measure of your credit behaviour and a significant determinant for lenders to assess your creditworthiness. Often, people are oblivious to their credit scores until their credit request is turned down. Hence, it is advisable not to wait until you apply for a credit to check your credit scores. Your credit score is a gradual buildup that can be improved with time. By maintaining financial discipline, utilizing credit responsibly and adopting habits that enhance your creditworthiness, as outlined in this article, you can gradually increase your credit score over time.
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