Imagine that you need to buy a new vehicle for personal use; you have a budget in mind, and you do your research, collect a lot of information from friends and family. A lot of factors are involved before you can buy a vehicle. You look up reviews for the vehicle, lookup reviews for the dealer before you make an informed decision. When you look up a review for a vehicle whether it’s from friends, family, online or by another other means, you are in a way gathering a score about the vehicle and the dealer. This score or review is then further broken by sub-category (Design, Mileage, Comfort etc.)

Let’s say you have made up your mind and you go to the dealer to purchase the vehicle and you want to take a loan. Just as you did your due diligence before selecting the vehicle and the dealer, the dealer (and the bank) need to do due diligence on you to see whether you are eligible to get a loan. This eligibility comes from your “Credit Score”.

A Credit Score is an insight into an individual’s financials and determines their credit worthiness. Banks and Financial Institutions will use the credit score to determine if a person is eligible for loan and what interest rate should be charged.

Who calculates credit scores and how?

There are multiple companies called Credit Bureaus that calculate the credit score. In India, the Government body which calculates the score is Credit Information Bureau Limited or CIBIL which it’s scoring in partnership with TransUnion. There are several other companies that also calculate the credit score - Experian, CRIF HighMark, Equifax.

Traditionally the credit score is calculated based on economic factors such as:

  • Credit Performance - This is a judgement of how well you have paid your loans or EMIs. If there are delays, then the scoring agency will put a penalty on the score. Depending on how long the loan hasn’t been paid, the score will be impacted significantly. This is perhaps the most important factor.

  • Credit Exposure - If you own credit cards, or house loans, the amount of credit line that is extended to you on the credit card or loan also impacts a lot on the credit score. Let us say you have a credit card with credit line of 1 Lakh and you have utilised 80,000 and making minimum payment will reduce your credit score.

  • Unsecured Loans - Taking a lot of Unsecured loans (personal or credit cards) instead of Secured loans (home, auto) is a bad idea.

  • Others - Finally there are other factors such as how many new loan requests, new opened accounts in your name. If the count is very high then the score is reduced. A word of caution - If you approach multiple banks for a loan, they will all check your score against CIBIL. This will severely reduce your score as multiple checks within a small time window exponentially negates the score.

The next article will explain what is a good score and how much score is needed in order to secure a loan.