What is a Credit Score. Why is it important
In the game of adulthood, credit score would be one of the highest scores one should have. What is credit score? Why is credit score important? And how did it come to be so important? Let’s see.
What is a credit score?
In simple words, a Credit Score is a standardized score or number that depicts your credit worthiness. A credit score would let the prospective lender (e.g. banks, finance companies) know if they could trust you to repay the money you borrowed. It usually is a 3-digit number ranging from 300-900. The higher your score, the more advantageous you are at availing credit.
Did you know, that before the credit score was invented (which was around 1950s), money lenders deemed a person credit-worthy in a more social approach?
For example, representatives from credit bureaus and prospective lenders would enquire local businesses to find out if a particular loan applicant was reliable enough to pay their loan in a reasonable manner. Moreover, loan officers used to also consider character conduct and sometimes personal judgements, while giving a loan. So if you were previously at odds with the loan officer, or for some reason they were just prejudiced against you, then chances of getting a loan from them was bleak.
Therefore, in order to have a more fair, impartial and standardized procedure for loan assessment, the credit score was introduced. You can read more about the history of credit score and how it came to be, over here.
In India, the credit score (or CIBIL score) is evaluated by 4 credit rating agencies- TransUnion CIBIL, Equifax, Experian, and CRIF Highmark. TransUnion CIBIL is the most widely recognized, hence, the term CIBIL score. In case you are wondering, CIBIL stands for Credit Information Bureau India Limited.
This article will take you through the importance of credit score and how you can maintain and sustain a good credit score.
Why is it important to have a good credit score?
Before getting into why it is important to have a good credit score, let’s look at one other important point.
What is a good credit score?
Majority of banks and finance institutions consider a score of 750 as ideal. Although different banks in India have their individual limit (to grant loans), you have a better chance at getting your loan approved if your credit score is above 900. The closer your score is to 900, or above, the better deals you get.
1. Qualification for Loan Approval
As a society, we have to depend on other people on a daily basis; even if it is in the smallest way. At some point or another, we may require someone’s professional expertise, service, or even social interaction. Nobody can make it completely on their own, especially when it comes to money. And let’s face it, sooner or later in our adult lives, we have all reached a point where we needed to borrow money. It probably began in small amounts from our friends; and then evolved gradually to bigger amounts, for more serious reasons, that we have had to go to banks or non-banking financial institutions.
Loans have become an acceptable way of life. But they say “loan availment is a privilege, and not a right”- which is true! Nobody wants to lend money to someone with reckless financial habits. Therefore it is very important to maintain a good credit score. After all, that number determines your financial habits, and can help or hurt you financially.
2. Lower interest rates
Yes, one of the most important reasons to have a good credit score is better interest rates on credit cards and loans. A good credit score will easily get you lower interest rates, and spending less on the interest will in turn help you pay off the debt faster and lets you save money for other expenses. Now of course a good credit score is not the only factor taken into consideration for a credit card or loan approval. But you can surely apply for a loan or credit card with confidence.
A good credit score can give you the upper hand while negotiating for lower interest on a credit card or new loan. It further helps if you have attractive offers from other banks or companies based on your credit score. Whereas a lower score does not give you the bargaining power, and creditors are unlikely to budge on the loan terms. You also will not have much credit offers and options.
4. Higher Credit Limits
Getting approved for higher credit limits is based on your credit score as well as your income. If you pay your bills on time, banks are more willing to let you borrow more money. This is because you have demonstrated that you have the capacity to pay back what you have borrowed on time. A bad credit score may still get you approved for a loan, but the amount would be limited.
5. Easy Approvals from Renters
In European and Western countries, landlords have many screening process to identify good, trustworthy tenants. The most common one involves looking into your payment history, so they know that you will pay the rent on time. This is mostly done based on your credit score. A bad credit score can create a hassle while finding a good apartment. Moreover, landlords ask for a higher security deposit amount if you have a low credit score.
6. Better Insurance Rates
Insurance companies treat you more favorably if you have a good credit score. It makes sense, since people with better credit scores are more likely to have the required funds and less likely to commit insurance fraud due to money issues. Typically, insurance companies use information from credit reports and insurance history to determine one’s insurance risk score. Some insurance companies penalize people who have low credit scores with higher insurance premiums.
How to improve and maintain a good credit score
Now that you know the perks and benefits of having a good credit score, here are some ways to improve and maintain a good credit score-
1. Keep your credit utilization ratio low
Your credit utilization ratio is (in rough words) how much you currently owe divided by your credit limit. It is a calculation that measures your credit usage against your credit limit. For your credit score to remain stable, this ratio should always have a limit of 30%.
2. Don’t cancel old credit cards
As time goes by, you might consider cancelling old credit cards. But when you close a credit card, the credit card issuer stops sending updates to the credit bureaus. There are 4 credit bureaus in India- TransUnion CIBIL, Equifax, Experian, and CRIF Highmark. Note, that if you are successfully able to maintain them and pay the bills in full on a timely basis, your older credit cards will show a richer credit history; which in turn works out in your favor by improving your score.
Learn more about common credit card mistakes.
3. Avoid Loan Application Rejections
With the loan marketing increasing and becoming more accessible, there are more options when you want credit. There are more and more new financial institutions that are offering loans. But that does not mean you should take loans every time an emergency arises, in an impromptu manner. When applying for a loan, make sure you are applying for one that is most eligible for you. Doing so will maximize your chance for approval , as loan rejections can lower your credit score.
4. Monitor your CIBIL report regularly
Yes, there are possibilities of errors occurring in your CIBIL report or credit report. For instance, your lender might forget to inform the bureau or credit agency that you have closed your loan, and they would not have updated your report. It is therefore wiser to check your CIBIL report regularly to correct such mistakes at the earliest, thereby maintaining your credit score.
5. Don’t take too many loans
As an extension of point 3, be responsible when it comes to taking loans. If possible, avoid having more than one loan at a time. Taking more loans is an indicator that you are greedy for credit, and therefore lowers your credit score. So taking multiple loans simultaneously would be a bad idea. Prioritize your needs and take one loan at a time to keep your credit score intact.
Read more on strategies to reduce your debt.
6. Choose a longer tenor for repayment
This will ensure you have a low EMI which will thereby help making payments on time and easily. When you do not delay, default or skip making EMI payments, your credit score will improve.
7. Choose different forms of credit
Everyone starts out without any credit history. So we all start off with a low CIBIL score. We have to build a good credit score by borrowing a healthy mix of credits including secure and insecure loans, with short and long tenor. This fundamentally proves our mettle in handling our loans and finances. Doing so will aid in getting lower interest rates and higher loan amounts in the future, especially for personal loans.
Following these habits can help improve your credit score gradually over a period of time. Obviously there will not be an immediate increase in your credit score. No matter what you do, a sudden improvement cannot be expected; consistence is key.