Monday, September 1, 2014

Everything You Want to Know About Your CIBIL Credit Score - Explained!!!

Though a Credit Score is extremely common/popular in the developed nations, this is still a fairly new concept in India. Yes, almost everyone is unaware of what this so called "Credit Score" is and how it affects us. The purpose of this article is to help you understand what this credit score is and how you can keep your credit score high (or improve the same if required)... 

So, what is a Credit Score?

A Credit Score is nothing but an indication of the "Financial Well Being & Repayment Capacity" of the Individual. Simply put, a high credit score would mean that he/she has a good repayment capacity (owing to their financial well being). 

In India, CIBIL is the entity that is issuing these credit scores. 

Who is CIBIL?

CIBIL stands for Credit Information Bureau India Limited. They collect and maintain records of individuals’ and non-individuals’ (commercial entities) payments pertaining to loans and credit cards. These records are submitted to CIBIL by banks and other lenders on a monthly basis. Using this information a Credit Information Report (CIR) and Credit Score is developed, enabling lenders to evaluate and approve loan applications. 

CIBIL is licensed by the RBI and governed by the Credit Information Companies (Regulation) Act of 2005.

Why Do I Need this Credit Score?

With more and more bad-loans plaguing our Indian Markets banks and financial institutions are facing huge risks because of borrowers who default without repaying their loan commitments. As a result, such a credit socre would serve as a warning to the bank or financial institution about the customers creditworthiness ahead of time. If the prospective loan customer is someone who has defaulted on one of your loans, his/her credit score would be affected due to the same and the bank where they are asking for a new loan will be able to identify this instance and handle them accordingly. 

As banks usually dont have access to credit information from other banks these credit scores are all the more important. Think of it this way, if a customer borrows 10 crores from ICICI Bank, spends it and then walks into HDFC Bank and gets another 10 crores, HDFC would have no clue that this guy has already defaulted on an earlier 10 crore loan. But, with these credit scores, HDFC would know that this guy is a defaulter and protect itself. 

So, if you are applying for a new credit card or a loan (any loan) the bank that you are applying with, will contact CIBIL and get your credit report/score. Your application will only be approved if your credit report/history is good. 

How to Understand these Credit Scores?

CIBIL is currently issuing credit scores called "CIBIL TransUnion Score 2.0" which falls into 3 different categories:

Category 1: NA or NH

If someones credit score is an NA or NH it would be because:

  • The Individual has no credit history & it has not been reported to CIBIL or 
  • The Individual has no credit history but has only been enquired upon or 
  • The Individual has credit history but none that is reported in the 24 months prior to enquiry or 
  • The Individual has a credit history but it has not been reported to CIBIL in the last 24 months

Category 2: 1 - 5

If someone has a Credit Hitory of less than 6 months, CIBIL does not have enough information to actually analyze and provide an accurate credit score. Hence they issue a rating of numbers between 1 to 5. Here a rating of 5 would mean that this Individual is comparatively of lower risk as against someone with a rating of 1 or 2 or 3 or even 4. So, effectively - higher this rating, the more credit-worth(low risk) the individual is. 

Category 3: 300 - 900

If someone has a Credit History of more than 6 months, CIBIL has sufficient information to analyze of data and arrive at an accurate score. Higher the score the better it would be for us. So, our aim should be to keep our score as close as possible to the 900 mark. 

Note: As soon as you cross the 6 month mark, your score will not be around 900. It will only go up slowly. 

What are the major factors that affect our Credit Score?

There are 4 major factors that affect our Credit Score

Factor 1: Payment history - Weightage 35% 

This factor has the highest impact on your credit score. Making late payments or defaulting your EMIs or dues (recently or frequently) shows you are having trouble to pay your existing credit obligations and will negatively affect your score. 

Factor 2: High utilization of Credit Limit - Weightage 30% 

Every customer has a "Credit Limit" Assigned by banks and utilizing a high % of this limit is not advisable. Just because you spend a lot on your credit card, your credit score wont be affected. Ex: If your credit limit is 50,000 and you easily spend about 25,000 each month and repay it every month, this will have no negative impact on your credit score. However, if the customer has a outstanding balance which accounts for a big-chunk of his/her credit limit, it will definitely have a negative impact. An increase in the outstanding balance or a steady high-outstanding-balance means that you still have a lot of outstanding debt and may face repayment pressure/burden in future and hence this will negatively impact your credit score. 

Factor 3: Higher % of Unsecured Loans - Weightage 10% 

Credit Cards and Personal Loans are considered Unsecured Loans (Meaning if you default, the bank cannot recover anything). In case of secured loans like Home Loan or Auto loan, if the customer defaults the bank can at least take possession of the car/bike/house and try to salvage some amount. So, if someone has only unsecured loans or a high % of unsecured loans, it could potentially affect your credit score. 

Note: If you have only unsecured loans but are promptly paying off your balance every month, this negative impact on the credit score would be very minimal to None. However, it would be a good idea to have a balanced mix between secured loans and unsecured loans. 

Factor 4: Opening Multiple New Accounts Recently - Weightage 10% 

When you start your career, you might apply for a few credit cards in parallel and this most likely wont raise a red flag. However, if someone is applying for 4-5 credit cards and maybe 3 or 4 personal loans, all in a span of 3 months, this effectively means that they are increasing their burder and could obviously have a negative impact on their credit score... 

When a customer wants to apply for a new Loan, banks will check on their existing loan commitments and if the customer has applied 2 or 3 more loans with different banks, his application would be scrutilized heavily. 

Factor 5: Length of Repayment History - Weightage 15% 

Ok, this is a tricky point. Not everyone has a loan or repayment history and this 15% part of your credit score will be really tricky. Anyways, as you start using your credit card or start your loan repayment, this length of repayment history will start to grow. So, the longer someone has responsibly repaid his/her outstanding dues, the better their credit score would be. 

Can I improve my Credit Score? If So, How? 

Not everyone has a 900 credit score right from day one. Everyones credit score goes from NA/NH (due to no credit history) and then 1-5 (due to little credit history) and slowly grows from 300 to 900. So, definitely we can improve our credit score. 

Idea No. 1: Always pay your dues on time

This is the most important criteria towards building a good credit score (or repairing an existing bad score). A Customer who repays his dues on time is always considered favorably by both banks & CIBIL. Similarly, Late payments are viewed negatively and will definitely impact your credit score negatively. 

Idea No. 2: Keep your balances Low

Thiis is another important criteria. Someone who has utilized just 15% of his overall credit limit is always viewed favorably in comparison to someone who has used 75% of his limit. So, always be cautious and dont use too much credit. Try to use cash as much as possible and keep your credit utilization to about 15-20% of your credit limit. 

Note: In case of loans, it is not easy to calculate your credit limit as easily as you can for credit cards. So, this point is mainly for credit card users. 

Idea No. 3: Maintain a Balance between Secured & Unsecured Loans 

It is always good to have a balance between Secured & Unsecured Loans. As I explained in the previous section, someone who has too many unsecured loans might have a lower credit score than someone who has a combination of secured & unsecured loans. So, it would be a good idea to rejig your loan portfolio and consider secured loans like Auto loan, Home Loan, Loan against shares/gold etc. 

Idea No. 4: Apply for New Credit - Only When Needed

People get carried away and apply for multiple credit cards at the same time (Mostly because the card sellers claim it is free and offer us a lot of free gifts). Appplying for a lot of new credit would make you seem Credit Hungry and could potentially have a short-term negative impact on your credit score. So, if you are planning to go for a new loan then you might want to reconsider that implusive urge to apply for 3-4 new credit cards now. 

Idea No. 5: Always Monitor your co-signed and guaranteed loan accounts Regulary

If you are a co-signed loan customer or a guarantor, you are held equally liable for missed payments. So, if you are a co-signer or a guarantor in a friends loan and this friend misses his monthly payment, this is definitely going to impact your credit score as well. 

So, be careful. I am not saying dont co-sign to help a friend. Just choose this friend wisely. Only do-so if you know this friend very well and are positive that this person wont default on their loans and screw up both their as well as your credit history. 

Last Idea: Always Review your Credit Score - Regularly

This idea might make me sound like I am actually selling on behalf of CIBIL, but it is always a good idea to review your credit score once ever year (at least every 2 years). Yes, this means you need to pay a small fee to CIBIL but this will help you avoid unpleasant surprises in the future. 

Some Last Words:

This whole concept of Credit Score is very good and is still relatively new in India. So, the No. of Instances where peoples credit scores are wrongly screwed up is still pretty high. But, CIBIL (And RBI) are both cautiously monitoring the same and taking steps to fix the errors. So, slowly our financial system will be able to identify willful defaulter easily and prevent bad loans. So, this is a good start. 

As customers, it is our responsibility to review our credit score regularly and take steps to improve it because a BAD credit score would mean Rejected Loan Applications... 

1 comment:

  1. Nice Blog Anand Sir. I stumbled to it when I was searching for some upsc economics topics and I found it really very helpful.The articles you have written are presented in a lucid manner to enable a layman to understand all these nuances. I learned many day-to-day financial aspects from your blog .Keep writing sir.



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