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What is a credit score?

The popular definition of a credit score is as such “A credit score is a statistical number that evaluates a consumer's creditworthiness and is based on credit history. Lenders use credit scores to evaluate the probability that an individual will repay his or her debts. A person's credit score ranges from 300 to 900, and the higher the score, the more financially trustworthy a person is considered to be”

Let’s make it even simpler, consider a class 12th student who has 5 subjects, in which he needs to get good scores to get into a good college. Now the average of the students score is what colleges look at before deciding on giving admission.

Credit score is exactly the same for a person which is a 3-digit number which is a got based on how you managed your past loans and credit cards dues. Just as a student will get into a good college if his score is good, a person with good credit score will get better offers when they apply for any type of credit.

Why is a credit score important?

Before we explore this section answer this simple question - “Will you lend money to a complete stranger?” Most of you will be nodding your head saying “No”. The only way you will think of owning money if you know the person or one you know vouches for them.

To put it in layman’s terms, banks were having the same problem in lending money because of the lack of parameters to make a lending decision. This lack of data also explains why loans were predominantly given to existing account holders or would take a lot of time to approve loans for new customers as it will take a lot of time to verify the given documents.

A person’s credit score is that friend vouching for another person. The credit bureaus have all the information on you based on your credit history and provides a background about a potential borrower to the lender (Bank or NBFC). So, the higher your credit score indicates that you have managed your credit better and this increases the chance of your loan or credit card approved and get better offers in the future.

Who calculates the credit score in India?

In India the credit scores of individuals are the domain of 4 credit bureaus – Equifax, CIBIL, Experian and CRIF High Mark. From lenders they collect the data of individuals who have taken any of credit compiling them in the form of a credit report based on which they calculate the credit score using their own proprietary algorithm.

Credit scores used to be an alien topic in India but not anymore. A survey found that 3 out of 4 Indians check their credit scores twice a year. Many Indians check their credit score to improve it while others check it to get a credit card or loan.

Even though many check their credit score to improve it, 3 out of 6 Indians were shocked to know that credit score is checked by lenders before approval of loan and that some mobile service providers check credit score before finalizing postpaid credit limit. This indicates that there is enough scope to educate Indians about credit scores and its importance.

Another factor is that Indians with income higher than Rs.5 lakhs check their credit score at least twice in a year compared to people with lower income.

What are the factors that determine credit score in India?

As mentioned earlier the credit bureaus use data from your credit history to calculate or arrive at your credit score. The factors that affect your credit score are

  • Payment history – The most important factor. How regular you are on your loan/credit card payments
  • Amounts owed/Credit Utilization – Having very high debts or maxing out credit cards with dues continuing for many months will have a negative impact on your score
  • Length of credit history – The longer the credit history, the higher the credit score.
  • Credit mix – Having multiple types of credit like personal loan, credit card and car loan shows that you can handle different type of credit efficiently and responsibly
  • New credit – Taking out credits within short time negatively affects your credit score
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