20-Feb-2019 written by : FSI-Team
Credit score has gained a lot of attention in last few years. The score which is a result of the complex algorithms run by the credit bureaus on the data available for an individual represents the credibility of the concerned person. In India the score ranges between 300 to 900.
A higher score signifies better past credit behavior and thus lower chances of person defaulting in future. While this seems to be quite a simple math, in reality the score is a multifaceted outcome that predicts possibilities of the borrower defaulting in future. Let us look at the factors that affect one’s CIBIL score.
The bureau takes into account the following five broad criteria to compute the credit score. Let us understand these in detail.
The repayment history on all the loans or other credit facilities availed by an individual in past form the most important criteria in the calculation. It carries a weightage of 35% and thus stands out in respect to the criteria that can affect the scores. While in western economies where the bureaus have had a presence of over 5 decades, the past record gets purged. However, in India the historic data, irrespective of the age, continues to be present and thus any default on any trade line will continue to impact the credit profile negatively. What is means is that one will not be able to escape past non-payments even if these are very old. In fact the data being used by the bureau today dates back even to the years when they were not even effectively present. One can obtain the free CIBIL report to validate this fact.
Amount owed is the total outstanding put together across all the currently active trade lines. Simply speaking, higher the obligation, higher the chances of the borrower defaulting. As a thumb rule the lending institutions peg 50% of the net income as the required amount for basic and necessary expenses like food, shelter, clothing, education etc. Let us understand this better through an example. A and B, both have an income of 50,000 per month. While the monthly obligations (EMI + credit card outstanding) is Rs 20,000; B has an obligation of Rs 5,000. Both apply for SBI personal loan of 2 lakh for 4 years. The loan EMI with 18% ROI comes at Rs 5,875. The total obligation for A and B including the new proposed loan EMI will be Rs 25,875 and Rs 10,875 respectively. Since A’s DBR goes beyond 25,000 the application gets rejected.
Again, the above example is only rudimentary and is not even indicative of the complex algorithm incorporated by the bureaus, a higher amount owed by the borrower will impact the credit scores grossly since it carries a weightage of 30% in the overall scheme of things.
Length of credit history is the number years the customer has been exposed to any form of credit history. It has two elements. First the total number of years elapsed from the date he opened first trade line and the vintage of currently active trade line. So a running home loan or a credit card will definitely have a positive impact on the profile since both these keep getting served for a long period. One should not look at closing the long standing card relationship just because a new card has been received. This factor carries a weightage of 15% in score calculation.
There are three kinds of credit instruments viz. secured, unsecured and revolving credit. Secured credit is one where the borrower has put up a collateral. A home loan, gold loan and even a card loan fall under this criteria. Unsecured is where the lending institution does not have any collateral to fall back upon in the event of a default. A personal loan, business loan etc fall under this category. The credit cards or any other form of limit where the borrower has the authority to decide what amount of the total outstanding he would with to repay, fall under the revolving credit segment. An exposure to all three kinds of instruments will impact positively. A 10% weightage is extended to this factor.
Recency of a trade line will also impact the scores. So every time one takes a new loan or any other form of credit, the scores are bound to see a dip but would get made up as the repayment happens over months. This factor also carries a weightage of 10%.
With a clarity on the criteria that impact the scores, one can look at working on it so as he has a stable and good scores.