All about the credit score you ever wanted to know?
What is a credit score and what factors impact your credit score?
Have you ever wondered why your credit score is very low? Were you confused about why your credit or civil score came out zero when you checked the same on the credit bureaus? Were you surprised to see that your credit score came down to certain points, from the last month?
Well if you are also the one who always fails to decode the credit score and needs more help in understanding how it works in its entirety you have come to the right place. We will debunk everything about credit scores in detail and try to answer all the possible questions that one can have in this article.
Let's get started with defining what is a credit score?
What is Credit Score?
Credit score comprises of two words credit + score, let's define them before we jump into the actual definition.
Whatever you own to someone or to some entity in the monetary sense which you have to pay is termed as credit. So whenever you take a loan or use your credit card or use BNPL or take cash from someone, you attach a liability on yourself that needs to be paid back as per agreed terms.
Now that you have understood what is credit, let’s discuss the score part of credit score. It is imperative to know that there are four credit bureaus in India;
- Crif Highmark
These credit bureaus are responsible to process all your credit information data that they received from Fintech, BFSI & NBFCs as per the RBI mandate. They leverage all your loan, and credit card details to score your creditworthiness, this score which ranges from 300–to 900, is leveraged by Banks and NBFC to decide whether they can give you a loan, credit card, or any other credit instrument for that matter. This score is called the credit score.
What all factors go into building your credit score?
Now that we are clear about what’s a credit score, it is time to understand what all ingredients go into building your credit score.
Your Credit Score is composed of the following key factors:
- Your Payment history: 35%
- Credit utilization (amount owed vs. total available credit): 30%
- Account age/length of credit history: 15%
- New accounts/ Hard enquiries: 10%
- kind of Credit mix/type of credit used: 10%
Let’s dig deeper into each of this one-by-one:
If you have taken any loan like a personal loan or a home loan or there is a balance on your credit card that needs to be paid and you are disciplined enough to pay all your EMI’s and dues on time without failing, this repayment behaviour has the highest weightage and accounts for 35 % of your overall credit score. Banks and NBFCs look into this attribute with the highest regard, so f you are running on a loan do ensure you are not defaulting on paying it back as per the agreed terms
Suppose you have a credit card with a limit of INR 100k and you are regularly making use of more than 60% of that limit which means you are utilizing 60K this utilization of the available credit is one of the key components that goes into deciding your credit score. By thumb rule one should always try to make use of only 30–40 % of the available credit limit else over leveraging beyond that will impact your score negatively. This behaviour accounts for 30 % of your overall credit score.
So it is recommended that full utilization of available credit limit should be a big no-no, else credit score can go for a toss
Account Age/Length of Credit History:
If you have taken a loan or any credit instrument and you have been maintaining the history of paying it back consistently for over a longer period of time without fail, this repayment history also accounts for your healthy credit score. The longer the credit history, the better your chance of having a positive impact on your creditworthiness. This factor accounts for 15 % of your credit score.
The only thing you need to be cautious about is that you are defaulting in repayment.
New accounts/ Hard enquiries:
Before we debunk this, we need to understand about
- Soft enquiry
- Hard Enquiry
Soft Enquiry: Whenever you are curious to know your credit score and go on to the portal of CRIF, CIBIL, EQUIFAX Or EXPERIA to enquire about the same you make a soft enquiry
If you are looking out for a loan or seeking a credit card and reach out to BFSI, NBFC or Fintech for the same they may first look to assess your creditworthiness for which they will make an enquiry with the credit bureau to fetch your credit details when they do so this enquiry is known as the Hard Enquiry:
Now that you know what are the enquiry type, let me tell you that for any soft enquiry which you yourself do there is an impact on credit score, but for every hard enquiry you may be penalized for trying to apply for too many loans and it is considered as a negative sign for the lenders. This behaviour of yours accounts for 10 % of the credit score.
Credit Mix :
When you have availed multiple kinds of credit instruments like home loans, personal loans, Credit cards, and education loans this mix of multiple types of credit products is called a credit mix. So if you are someone who has a mix of credit products, you may end up damaging your credit health negatively. This credit mix accounts for 10 % of your total credit score
What Does Credit Score Signify?
In India, the credit score ranges between 300–900 across all the functional credit bureaus, the higher the score the better is your creditworthiness. Let’s decode the number and see what it signifies. We will take the CIBIL score as a reference here
350–549: A score in this range is considered a bad CIBIL score. This score generally means that lenders will refrain to give you a loan as they will you see as a person who may default
550–649: This score falls under the fair category but is still a red flag as this also signals to the lenders that you may not have an easy ride while paying back your dues, but still you have some fair chance to get the loan with one caveat your interest rate will be on the higher side
650–749: This is considered to be a good credit score, lenders will love to give you a loan, since your credit score is good, you should negotiate the interest rate on offer as multiple lenders would be happy to chase you down. So try to get the best deal possible
People with this score are considered to be the creamy layer and fall under the excellent category. If you are the one with this score lenders will love to offer you loans with the lowest possible interest rate. Your bargaining power will be more as you are the person with the lowest risk for the lenders and they see you as the most credit healthy person.
These scoring parameters more or less are the same for all four credit bureaus
Things you should know:
- Do you know that when you have multiple credit cards and you want to get rid of all except the one you want to keep, closing all those credit card accounts can impact your credit score negatively? This happens because your long credit history with those cards gets vanishes which hampers your credit rating. So if possible just keep those credit cards and be disciplined with your spending.
- Are you aware that if you are new to credit and want to build your credit score from the ground up, you can do so by getting yourself attached to some of your close relatives and friends who are holding the credit card and can make you an authorized user of the same? The only thing you should ensure is that you are not defaulting your payments and spending small and paying back the same on time. This will help you slowly build your credit score.
- Also, you can open a fixed deposit with your bank and ask them to issue a credit card against the same. Banks may not hesitate to give your credit card just because you have no credit history as you have deposited the security amount in the form of FD. This way you can start your journey to build your credit score. Just ensure you are not overspending and repaying the dues without fail
Summing Things Up:
A credit score is a reflection of how disciplined you are when it comes to paying back what you own, so it is always recommended that you are never over-leveraging credit instruments just for meeting your unwanted expenses and in case of emergency if you are swapping it you need to ensure there is enough income to help you payback. If you are not sure about your income you should refrain from over-spending else you may get into the debt cycle that credit card has brought to many people's life.
This debt trap can be precarious as the interest rate for default is 30–40 % which may damage your financial health heavily. Also if you are not able to repay there is a high chance that you may end up taking up other credit products to repay the credit card dues and this is how you end up in the liability loop.