When a bank or an NBFC (Non-Banking Finance Corporation) loans any amount to you, in form of a credit card, cash credit, personal loan, or a home loan, it takes a risk on your account.
This is why no bank will usually grant any amount of loan at the standard rate of interest. After factoring in their positions, they work out an arrangement that keeps them secure.
So, Manoj, a well-to-do businessman approaches a bank for a loan of Rs. 10 lakhs, while Manish, at a similar income level asks for the same amount from the same bank. The bank lends 9 lakhs @ 8% p.a. to Manoj and Rs. 7.5 lakhs @ 8.75% p.a. to Manish. Why?
Because Manish’s credit score was lower than Manoj’s.
Now, what is a credit score? How does it help the banks determine lending terms and what can you do about it?
A credit score is a number ranging from 300 to 900, which quantifies your creditworthiness. A higher score means you’re a secured borrower and most likely to pay all dues on time. A lower score means there is a risk of overdue payments or even waivers.
Since Manish’s score was lower, it meant the bank was taking a high risk with his loan. This caused a higher interest rate – to compensate for the increased risk.
The credit score is an often-neglected factor in personal finances; it is one of the major factors affecting your rate of interest as well the amount of down payment while purchasing an asset on EMI.
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Banks don’t. There are four recognized credit bureaus that put a number to your creditworthiness after weighing in various factors – the length of your credit history, repayment records, credit inquiries, etc.
A credit score in India ranges from 300 to 900. A higher credit score reflects timely payments on your end – which impresses lenders and assures them of disciplined payments. Banks don’t worry about giving loans to high scorers because it means a low risk of defaulting.
When a bank feels safe sanctioning credit to these high scorers, they also benefit in the following ways:
The banks refer to one of these credit companies for your credit score –
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Your bank sends information on every transaction that could be relevant to your credit score to the credit companies. This information may include:
The banks can approach any one credit company to get a credit score. Your credit score remains the same across all bureaus.
You should monitor your credit score regularly to make corrections if it drops. The ideal score to get peaceful sanctions is 750+.
So, what can cause your credit score to dip?
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Being a young adult, with hardly any finances to take care of, it is possible to not have any credit history at all. That doesn’t mean you don’t have a score. All bureaus rate you at -1 when there is no credit history.
When you borrow for the first time, the first six months show a NIL rank. Only after a year can you get a clear credit score.
If you wish for an easy financial journey in the future, your credit score needs your attention now.
Start your credit journey with proper guidance.
Here’s how you can start a peaceful credit journey:
It is not an overnight job – your credit score needs time to build. Don’t fret much over it, don’t ignore it either. Disciplined, consistent repayments are all you need!