What is Credit Score? How To Improve and Calculate it?

A credit score is an indicator of the creditworthiness of a person or entity. The score is a point system based on which higher points are given to those who maintain a good relationship with credit. This means that every time the person repays EMIs on time and pays credit card bills on time, the credit score is impacted positively.This score is given by a licensed organization that carefully assesses an individual's financial history and assigns points based on each credit activity to arrive at the final credit score. Therefore, any lapse in a single EMI payment can affect the credit card application because it reduces the credit score.This score helps lenders like banks and financial institutions offer loans carefully and at the appropriate interest rate to protect themselves from potential default. They may also deny loans to someone with a poor credit score and a history of defaults. Creditors and landlords also assess a person's credit score because it determines whether the person has a habit and the funds to pay dues on time. Also Read : CIBIL Score For Personal Loan

Lenders, landlords and creditors can use a credit score to protect them from possible default cases. At the same time, a good credit score also offers many advantages to potential borrowers.Someone with a good credit score could get the following benefits:

1. Better interest rate on any type of loan
2. Better terms and conditions, like choosing the tenure of any loan
3. Higher loan amount
4. Seamless processing of the loan and faster disbursement
5. Better negotiating power for loan terms
6. Applying for credit cards with ease
7. Higher credit limit on the credit card

Credit information companies collect and manage information about an individual or entity's credit-based transactions. Since all credit transactions are linked to a government-issued ID like a PAN card, these credit information companies can collect and assign them to each individual or entity. This database is constantly updated in real-time and used by credit-rating agencies to assign a credit score.One of India's four authorized credit bureaus is TransUnion CIBIL Limited. Credit Information Bureau India Limited, also known as CIBIL, is India's oldest credit rating agency. They merged with TransUnion, an American company, and received their current legal name, TransUnion CIBIL Limited. This organization assigns the CIBIL score .A CIBIL score is assigned between 300 to 900, with anything closer to 900 being the best. A score above 650 is considered good. A score is considered poor if it is between 300 and 500. An average score is between 550 and 650. Usually, a score between 650 and 750 is considered a good score, but a score over 750 is the best.The approval probability of a loan or credit card is extremely low for those with a credit score below 600. Creditworthiness, in this case, is considered to need attention before approving any credit. If someone has a score between 600 to 650, getting credit may be difficult, and the offers will be really low. Creditworthiness, in this case, is considered doubtful, and lenders should proceed cautiously. If the credit score is between 650 to 700, the creditworthiness is fair, and credit approval should be possible but won't have the best offers. A score of 700 to 750 is considered good, and above 750 is considered excellent. This is usually the range that gets the best credit offers with attractive terms.The other three Credit Information Companies were established following the introduction of CICRA in 2005. Credit Information Companies Regulation Act is referred to as CIRCA. They may slightly deviate from CIBIL in their own grading system. These three credit bureaus are:

1. CRIF High Mark Credit Information Services Private Limited
2. Equifax Credit Information Services Private Limited
3. Experian Credit Information Company of India Private Limited

A credit report may have different components and different formats depending on the credit-rating agency that releases them. However, some common must-haves in any credit report are as follows:

1. Credit Summary This section is usually a brief about the credit history of the person or business entity. It will include existing outstanding dues of loans, credit cards, and bank accounts. It may also include past dues that were recently closed. This section gives a brief snapshot of the credit history of the person or entity.
2. Account History This section goes into the details of all credit accounts. This includes loan accounts, credit cards, overdraft accounts and bank accounts. Details like the date on which the loan was disbursed, account number, date of creation of the account, current outstanding balance and monthly repayment schedule of up to 3 years can be viewed here. It contains the details of the credit-related transactions undertaken by the person or business entity.
3. Public Records This contains a list of defaults that are public information. It typically includes major concerns like imprisonment related to financial crimes or bankruptcy and not defaults like missing to pay one EMI. They are typically the strongest contributors to a low credit score because of their seriousness.
4. Credit Inquiries There are two types of inquiries when it comes to credit - a hard inquiry and a soft inquiry. Banks or financial institutions either make these inquiries to check the credit report of a potential borrower or by borrowers themselves to check their own credit report. A soft inquiry means when borrowers check their credit score, employers perform a background verification, or financial companies assess their audience for marketing and sales purposes. A hard inquiry is a more detailed inquiry into a person's credit report. It requires the explicit approval of the person whose credit report is being generated. This is usually undertaken before disbursing a loan or in response to a new credit card application within 2 years. The effects of a hard iniquity typically last 2 years on the check score.

A credit score may be affected by many factors, as discussed above. Understanding them may enable borrowers to make prudent credit choices that improve their scores and help them gain favourable interest rates and credit options.Here are some of the factors that may affect a credit score:

1. The history of repaying credit: Missing an EMI or credit card payment or paying after the due date negatively influences a credit score. A person's credit score is impacted favourably when they pay their credit card bill or EMI on time. But, it is seen unfavourably if they don't. Banks also check for this because it indicates a person's ability to repay loans.
2. Dues like credit card bills are paid in full: With certain credit cards, people can opt to pay just the minimum amount due each month and carry over the remaining due amount for another month. This can also spark a lot of curiosity on behalf of potential lenders and raise doubt about the repaying capability. But, because it casts doubt on one's ability to repay debt, failing to make credit card payments on time and in full can drastically reduce one's credit score.
3. Current existing loans and other dues: If a person is already in debt, they may be paying a lot of EMIs and may not have enough funds to repay any more loans. Therefore, having many loans and opting for more or many credit cards and opting for loans may result in a lower credit score.Banks and other financial institutions know that, despite prompt repayment of existing debts, repaying a loan on top of that can be difficult. Therefore, they may not approve further credit if there is a lot of existing credit given to a person.
4. Past transactions related to credit and ability to repay dues in the past: Having some form of credit creates a vital paper trail proving that the potential borrower understands the importance of paying dues on time.Therefore, a good score won't be possible if the person has never had a credit card or loan. It would give the banks and financial institutions no basis for determining whether the person will be diligent and disciplined enough to make on-time payments. Hence, a higher credit score will be obtained if you already have a positive relationship with credit (credit cards, loans, etc.).

Since CIBIL is the most widely used credit score, let’s take a deep dive into how much weightage each credit-based transaction has on a credit score.

1. Repayment history: This has the highest impact on the credit score and is usually up to 35% of the credit score. It refers to the relationship that a person has had with credit in the past, which means if the person has managed to pay many EMIs and pay credit card bills monthly in full and on time for a long time, then that means the credit repayment history is good. The person is given a higher score. If someone made one default in repaying a credit bill 5 years back, then it has a slight impact, but if someone failed to pay a credit card bill in the last 3 months, it has a bigger impact.
2. Credit balance and level of utilisation: This refers to the amount of credit that the person has but has not used. Typically, if someone swipes their credit card for Rs. 2,000 every month but have an Rs. 10,000 credit card limit, Rs. 8,000 or 80% is their credit balance, and Rs. 2,000 or 20% is their level of utilisation. This has a 30% impact on the credit score. It also applies to loans when the sanctioned amount exceeds the amount disbursed. Keeping a high credit balance and low level of utilisation has a positive impact on the credit score.
3. Tenure of credit: This has a 15% impact on the credit score. It refers to the duration of the repayment and factors in the duration of timely payments made. Therefore, if someone has a loan of a longer duration and has been paying it on time, they will have a better credit score than someone with a short-term loan. This points to the prolonged repaying capability of the borrower.
4. Fresh credit cards or loans: This has a 15% impact on the credit score. However, these constitute very minor transactions that could lead to a negative impact on the credit score. Any inquiry made into the credit score could be looked at as a plan to avail more credit which has a negative impact on the credit score. New loans and credit cards also negatively impact the credit score in a large way. New loans and inquiries signify the need for credit, which raises questions about the liquidity of a person.
5. A mix of credit instruments: The credit score also has a 10% impact from having different types of credit instruments. This means a mix of secured loans and unsecured loans and a mix of short-term and long-term dues. Therefore, a long-term home loan, a short-term collateral-free personal loan and a credit card are considered a good credit mix.

RBI has approved only 4 credit information companies. The way they calculate the credit score of an individual differs slightly. Here is a brief comparison of the 4 agencies.

1. Most popular agency
2. Offers additional surveys like portfolio reviews and researched market insights.
3. Range of scores is 300 to 900

1. Range of scores is 300 to 850. Anything about 720 is good, and below 640 is poor.
2. Offers geo-analytics consulting

1. Ranges from 1 to 999.
2. Offers credit risk and fraud management services.

1. Ranges from 300 to 900.
2. Offers customer acquisition and insightful data analytics

1. CIBIL:
2. CRIF High Mark:
3. Equifax:
4. Experian:

All bank accounts are associated with a PAN Card . Therefore CIBIL would already be aware of the current balances and loans that are still owing. Therefore, it is always advisable to periodically check and update the dashboard that calculates the CIBIL score. This will enable people to monitor their credit histories and identify areas for improvement. Here are a few best practices that could raise your CIBIL rating.

1. Avoid too many loan applications unless you need them. There are two types of inquiries when it comes to credit - a hard inquiry and a soft inquiry. These inquiries are either made by banks or financial institutions to check the credit report of a potential borrower or by borrowers themselves to check their own credit score. A soft inquiry means when borrowers check their credit score, employers perform a background verification or when financial products assess their audience for marketing and sales purposes. A hard inquiry requires the explicit approval of the person whose credit report is being generated. This is usually undertaken before disbursing a loan or in response to a new credit card application within 2 years. Too many hard inquiries are considered to be representative of a sudden need for money and an increase in debt which ends up reducing the credit score. The effects of a hard iniquity typically last 2 years on the check score. Borrowers can plan their debt in such a way that they space out the hard inquiries by avoiding additional debt within 2 years of existing ones.
2. Always limit the expenditure on credit cards to 30% of the credit card limit. If someone has multiple credit cards, they should split their usage so as to avoid crossing the 30% limit on any of the credit cards. Though a credit card limit may be very high and the user can take full advantage of it as long as they are repaying on time, it is financially wise to use only 30% of the total available credit limit so that it doesn’t negatively affect the credit score but keeps creating a healthy credit history as well. Dues also include short-term dues like converting card bills into EMI. Sometimes, financial institutions also offer short-term credit in the form of zero-interest EMI options for purchasing retail items. These also impact credit scores and must be factored in the 30% limit.
3. Keep a check on the due date for clearing dues (EMIs and bills) Even a single day of late payment on credit cards and EMIs might lower your credit score. In order to ensure they don't forget a payment, borrowers should set up auto-debit services. Even though there is no additional expense, credit card bills should never be carried over and must always be paid in full.

1. Opt for institutions that don’t categorise as banks. Though their interest is typically much higher than banks, this option can be used in case of emergency. However, the borrower must carefully read the terms and conditions before opting for such lenders.
2. Have a co-applicant on loans: When there are two applicants, the responsibility of repaying the loan gets split into two. If the co-applicant has a higher credit score, that can be used to increase borrowing capability and negotiating power.
3. Applying with a guarantor: When a person with a good score attaches their guarantee to the loan applicant of someone with a poor credit score, it enhances the chances of the loan application getting approved.
4. Securing the loan with an asset: Having an asset that can be kept as collateral could give the banks and financial institutions some trust in the repayment ability of the person. However, the borrower must understand that in case of continuous default, the bank will be able to take possession of the asset and liquidate it to recover the loan amount.
5. Show income proof: If the potential borrower is earning well and can show significant proof of income, like income tax returns and salary slips, there may be a chance that the loan gets approved if there are no other credit dues and the EMI is less than 30% of the monthly income.