The Reserve Bank of India (RBI) mandates all lending organizations to check the CIBIL score of the borrower while evaluation and disbursing any loan.
It is because of this reason; every lending organization has different parameters or checks and balances in place to judge whether or not to issue a particular loan to an individual.
Therefore, this week we will discuss about CIBIL score, its importance and why is it instrumental to maintain a good CIBIL score to for any application of loan, be it home loan, or any other personal loan.
CIBIL score is a three digit number ranging from 300-900 based on which our credit history can be known. In order to get to our score, the Credit Information Report (CIR) is helpful as it summarizes our payment history of loans and credit cards payments from all banks and financial institutions.
The interpretation of this score is simple, meaning, the closer we get to 900, the better is our CIBIL score and thereby this enhances our chances of securing loans.
CIBIL score is the first criterion set by banks and financial institutions, when reviewing the loan application process. Therefore, it becomes utmost important to get this score in place.
Today, though CIBIL score lenders are able to differentiate between those who have honoured their obligations responsibly and those who have defaulted. Which means, they are able to gauge the potential prime borrowers vs. the sub-prime borrowers.
Individuals who have managed their obligations appropriately build ‘reputational collateral’ with lenders. In turn, this reputational collateral may allow individuals to negotiate better terms with a lender.
In the illustration shown below, there are two individuals applying for home loans and have credit scores of 810 and 620 respectively.
Depending on the credit policy set in place by the bank, it is more likely that the bank will screen the individual with a higher credit score i.e. 810 for further evaluation, while the application with the credit score of 620 may not be processed.
A credit score is looked upon by the lenders (mainly banks and financial institutions) to determine our creditworthiness.
So whilst a CIR (Credit Information Report) is just like a report card, a credit score is like the overall rank that we get. It takes into account all the information in a CIR and returns a score value which quantifies our credit and financial health.
So, by looking at our credit score, we can get a sense of your financial position and standing.
A low credit score does not mean that your the loan will not be processed, but in addition to the credit score, the CIR, income and existing loan obligations (debt-burden ratio) also plays a key role in the evaluation of the loan application.
So, if we have a low credit score, Bank X may not approve our loan while a Bank Y may do so, depending on their respective credit policies. Say for example Bank Y may do so by charging a higher interest rate.
Let us now discuss the elements we can fix in order to improve our credit scores.
The first and foremost thing to carry out is to pay off the balance that we owe. This pertains to both bank loans and credit card payments.
We should also negotiate with banks to close the loan account by paying off the unpaid loans in requisite time. The unpaid loan amount brings down our credit score and post clearing our debt, there is a positive reflection on the CIBIL score.
Also, in order to reduce any hassle, we should not have more than two credit cards as it becomes very easy to track the payment.
We should also make sure to report immediately to cibil.com in case of any wrong reporting in regards to any particular transaction.
There have been instances when lenders have been involved in making inaccuracies.
Also, it is mandatory for any financial institution to act on such cases within 30 days of the dispute filed. As soon as the dispute gets settled, the CIBIL score shows a marked improvement.
Therefore, we should only apply for loans after resolving the pending issues if any.
It is best to hold the credit card, the bills of which we have paid regularly. Such a scenario acts as a boon for us as lenders to look for past data and instances, wherein we have honoured our payments.
Though there might be situations wherein we will not use the credit card for a long time, holding on to it adds value to your CIBIL score as it reflects financial soundness.
If you are thinking of availing loan to buy a house or a new car, it is imperative to continue paying your present EMIs in time for banks to consider your portfolio for loan disbursement.
If you fail to do the same, a negative score might actually shatter your dreams of owning a house.
Hoarding huge amounts of cash for the dream to realize might also not work during such circumstances as CIBIL score is the first criterion used by the financial institutions to take the procedure of loan approval forward.
Therefore, it is important to pay the current EMI on time.
The credit utilization ratio defines the percentage of total borrower’s credit that is being utilized. For example, I have two credit cards with the following credit limits:-
|Credit Card 1: Limit available 100,000||Credit Limit Used: 40,000|
|Credit Card 2: Limit available 200,000||Credit Limit Used: 50,000|
Based on the above example, we can see that the total credit limit available for me is Rs. 3,00,000 and I am using only Rs. 90,000 of that, meaning my credit utilization score is 30 percent (90,000/300,000).
It is said that keeping a credit utilization score of 30 percent or less is considered fruitful. Meaning, we should not use our credit cards for everything that will induce a positive reflection on your CIBIL score.
When we ask our bank to raise our credit limit, it does not mean that we have a free hand of spending the entire amount. But there are a number of reasons as to why these are useful as discussed below:
This methodology can be adopted by a person who has a bad CIBIL score.
Getting a secured credit card is possible against a fixed deposit. Leading institutions in India such as ICICI Bank, SBI, Citibank, Axis Bank provide such secured cards. By paying off the balances in time, we can subsequently increase our CIBIL score.
Disclaimer: The views expressed in this post are that of the author and not those of Groww