In recent years, credit score has become synonymous with loans in India. The concept of a Credit Score has been around for ages but the idea behind it is still very new to the Indian population. Misconceptions like no loans mean a better credit score has long-plagued Indians
CREDIT=BAD is something a lot of us have learned from our parents. The 2007-2009 economic collapse of the United States of America, which was rooted in credit, also drove home the fear of having credit to one’s name.
With assets that require large fiscal investments like property, credit is a crucial way of financing. This brings us to the idea of learning what a credit score is and how it can help you when financing your home with a Home Loan.
What is a Credit Score?
A credit score represents a loanee’s creditworthiness.
In simple words, a credit score is your likelihood of being able to pay back the loan you have asked for. A credit score is a three-digit number given to you by a financial institution after making a detailed analysis of your financial decisions up until the day you apply for a credit score report.
You can either simply receive a credit score or apply for a detailed credit score report. We will be talking about it in-depth as this blog proceeds.
When you apply for a loan of any kind, you’re put through a very extensive financial analysis. Your salary slips, Income Tax Returns, bank statements, and credit score are placed under a lens and dissected. This financial analysis tells the banks how capable you are of paying off the loan that you have applied for and how likely you are to become a defaulter.
If you have a high salary, any lender would be eager to pass you the loan as you have the resources to pay them back, a.k.a. the bank is taking a lower risk with you. Similarly, if you have a high credit score, it evokes the same reaction.
What is a CIBIL Score?
Anytime the topic of a credit score is brought up, a CIBIL Score is also a part of the conversation.
CIBIL, also known as Credit Authorization Bureau (India) Limited is an organization that has been authorized by the Reserve Bank of India (RBI) to calculate an individual’s credit score. After an extensive analysis of your financial records, an arm of CIBIL, called TransUnion CIBIL gives you a detailed Credit Report.
Your CIBIL score ranges from 300-900, 900 being the better end of the score range. Lending institutions provide TransUnion CIBIL with their data every 35 to 40 days. This helps TransUnion CIBIL in creating a highly dynamic, accurate, and recent credit report and score. Thus, your credit score can rise or fall depending on your financial habits.
How to Calculate your Credit Score?
Fortunately, as we discussed before, you don’t really have to calculate your Credit Score by yourself. There are multiple credit bureaus in India that can provide you with a credit score. As we have mentioned in the previous section, TransUnion CIBIL is one of the most prominent and sought-after credit bureaus for a credit score report. However, there are three more credit bureaus in India that one can turn to for a credit score.
1. CIRF High Mark
Established in 2007, CIRF High Mark received its credit agency license in 2010. Their credit score ranges from 300-900.
A lending company that started in 1899, Equifax became a licensed credit rating agency in India in 2010. Their credit score rating starts at 1 and ends at 999.
Established in 2006, Experian received its license to grant credit scores in 2010. Similar to TransUnion CIBIL, the credit score for Experian ranges from 300-900. They generally deliver credit score reports in 20 days and are priced comparatively lower than their competitors.
Good, Bad, and Average Credit scores
To understand what a good, bad, or average credit score is, we’ll stick to the TransUnion CIBIL credit score range, i.e 300-900.
Your TransUnion CIBIL credit scores are determined by the following factors:
|Factor||% of consideration|
|Credit Type and Duration||25|
As per the 4th point on the table above, some of the other factors that affect your Credit Score are as follows:
Paying only the due minimum amount.
Not having a good credit mix.
Making multiple credit inquiries simultaneously.
Factors like your Savings Accounts, Fixed Deposits, Income, Overdrafts, and Bounced Cheques do not affect your credit score.
We can now look at the range of what is a good, bad, and average credit score.
Importance of a Credit Score in home loans
Apart from the fact that a credit score helps banks/home loan financing institutions understand your capacity to pay the loan back, it also helps you get home loans at premium rates.
You come across marketing tags that say “Home loan by XYZ Bank now at rates as low as 4.5%” and make an assumption that the rates at this bank are the lowest you can find. The reason this assumption is false is that the 4.5% interest rate will only be available to borrowers with a credit score over 750. Everyone else will be offered a slightly higher rate of interest by the bank after a financial background check is performed.
This is the power of credit scores in home loans.
Affect of Credit Score on Home Loans:
|Score Range||Affect on Interest Rates|
|750-900||Instant approval of loans at a lower interest rate.|
|710-750||Loans are approved fairly quickly at market rates.|
|650-710||Loans approved after more checks at a slightly higher interest rate|
|580-650||Loans get approved only at higher interest rates.|
|300-580||Loans mostly get rejected and the ones approved are at a very high-interest rate.|
Common Misconceptions About Credit Scores
Here are some common misconceptions that borrowers have about credit that negatively impact their credit scores.
Trying to improve your credit score overnight
Your credit score cannot be improved overnight. Just take this as a general fact and run with it. Since your credit score is an analysis of your credit history, it needs to be carefully curated over time.
Whether you have a low score due to non-existent credit history or irresponsible payment behavior, taking major steps to rectify it within the next month would again reflect poorly on you. It would signify that you’re doing so simply to take out large loans and decrease your creditworthiness even further.
Becoming a guarantor on a loan
Becoming a guarantor on a loan can also negatively impact your credit score. In case if the borrower you have signed up as a guarantor for defaults on any of their payments, the liability of making that payment falls over you.
You may know this borrower closely and wholeheartedly believe they wouldn’t default on a payment, even then this financial decision has the power to affect you. It diminishes your credit limit significantly by the amount of the loan you’re a guarantor for.
Your credit score report is the latest to the minute
As we discussed earlier in this blog, financial institutions submit their information to TransUnion CIBIL in 35-45 days. This means that although your credit score report is up to date every quarter of the year, it can and will never show your real-time creditworthiness.
For example, if you’ve recently applied for a credit card and made the payment on its bill, or repaid in full an existing loan, it will not reflect in your credit score immediately. Generally, it would take over 30 and up to 60 days to reflect in your credit report.
Closing old credit card accounts
A lot of people look at a bad score and rush to close old credit card accounts. What you’re doing here is redacting long-standing credit history that could have improved your creditworthiness.
Old credit cards that have a good repayment history are great signs of a borrower being low risk. In addition to that, credit bureaus also take note of the length of your credit history and thus a long-standing credit card adds to your credit history.
I just need to pay the EMI even if it is a couple of days late
Unlike your college assignments, credit bureaus don’t believe in extensions on loan payments, credit card bill payments or EMIs. They are interested in how often you make this payment before the due date and how much of the charge you are willing to pay every time.
If you make late payments on your current credit, it wouldn’t matter whether your credit has been paid in full. The credit bureaus will still acknowledge it as irresponsible financial behaviour, impacting your credit scores negatively.
Having no credit is a good thing
This is the biggest misconception that borrowers have. “But you have no loans and credit cards, why would your credit score be low?”
Let’s first dissect the mentality behind this sentiment.
Your credit score isn’t something that starts at 900 and reduces as you make irresponsible credit decisions. It’s the exact opposite. Your credit score starts at 300 and improves as your credit history lengthens and you make smart credit decisions. So thus, no credit does not mean a good score. It just means you haven’t even started building a score yet and have no creditworthiness to show to a lender.
Credit Cards and Credit Score
Your credit card might be one of the most impactful factors on your credit score report that you commonly mess up with. For anyone with a poor credit score, we suggest thoroughly going through your credit card usage and payment habits.
Here are a few credit card practices that might be hurting your credit score
If you have the habit of only paying the minimum amount due on your credit card and not the interest, it will significantly reduce your credit score.
One important thing to keep in mind while using credit is to use only 60% of the credit available to you. Maxing out your card can be seen as a sign of financial instability and result in a lower credit score.
If your credit card application has been rejected in the past, make sure you find the root cause and rectify it before making another application. Multiple rejections significantly lower your credit score.
If you’re in dispute regarding a charge on your credit card, simply pay the charge when the bill arrives and wait for your credit card company to revert it once the dispute is solved.
How to Improve your Credit Score?
We have gone over your credit score, why it decreases, what affects it, and why it’s important when you need a home loan in detail.
But what do you do when you have a low credit score?
Do you simply give in and reapply to another financial institution? Or do you have to take the loan at the high rate of interest that the bank is offering you? Maybe you don’t even require a loan at the moment and are just prepping for the future. In any case, there are a few steps that can be taken to improve your credit score immediately and over time.
Now be careful when you read the word immediately in the previous sentence, this is only a form of resolution present if your credit report contains an error. In any other case, these are steps that can help you improve and maintain your credit score over a long period of time.
Go through your Credit Report
Check your credit report thoroughly. You might not be a financial wiz but trust us when we say everyone needs to take a close look at their own credit history to understand why they’re getting a low score.
If you struggle with understanding the report, have an accountant, a close friend, or a family member look at the report and explain it to you. The first thing it’ll do is help you understand which credit behavior of yours is lowering your credit score. Secondly, it will help you catch any errors in the report early on and have them rectified before they can have a serious impact on your borrowing capacity when you need a loan.
Dispute any errors in your Credit Report
TransUnion CIBIL allows any borrower to dispute errors on their credit reports for up to 30 days. To dispute a wrong charge or an incorrect transaction, all you need to do is visit this CIBIL credit score dispute page and raise a dispute.
This is a free-of-charge service provided by CIBIL and you’re allowed to select multiple transactions if you want to raise a dispute.
Understand and make note of your credit utilization ratio
Whether you’re starting with building your credit or have been working on it for years and still see bad numbers in your credit score report, you should take note of your credit utilization ratio.
The credit utilization ratio is the amount of credit you currently use over your credit limit. The ideal credit utilization ratio in India is 30%. If your report shows a higher credit utilization ratio, cutting it down might be a good way to improve your credit score.
Don’t apply for credit immediately after a rejection
It sure would be very tempting to run to another lender on getting rejected on your loan application, especially when you need the loan urgently. However, if it’s possible, try not to do that. Wait and work on your credit score to improve it. Your previous rejection will reflect on your credit score report and thus create uncertainty for the next lender you go to as well. This makes your chances of getting rejected again high.
Don’t apply for credit often
Even if you can afford to get credit, i.e. pay it on time and not default, applying for credit too often creates a downward spiral in your credit report. Since every bank asks CIBIL for your credit score report when you apply for a credit card or a loan, their query gets lodged in the report.
This means if you apply for credit often it makes you look credit hungry, and also reduces your score. This means the risk associated with giving you credit increases. In turn, this will make banks reject your application which further reduces your credit score creating a downward graph on your credit score report.
Create a good mix of credit
There are two types of credit that any person can receive, secured and unsecured.
Secured credit is credit you take against an asset that you already own. For example, loans taken out against property or gold come under the category of secured credit. On the other hand, unsecured credit is a credit not collateralized by an asset you own. One of the most common examples of unsecured credit is credit cards.
People with a high credit score will usually have a good mix of both secured and unsecured credit. This shows the lenders that you’re capable of and willing to pay all types of loans irrespective of the stakes attached to them, increasing your creditworthiness.
At the end of the day, you will still be eligible for a home loan even if your credit score is low. It would, however, make finding a credible lender who isn’t charging you an arm and a leg in interest rates very difficult. Think of a credit score as the road you take to work. On the days when there's a traffic jam, you still get to our office. It might take you a lot longer, and frustrate you, but you still get to work.
A good credit score on the other hand would feel like working from home. There is no struggle to get from your home to your workplace. If you would like to not be frustrated on your home buying journey, then maintaining a good credit score is the way to go.