A large part of the world today runs on credit. For example, businesses, small or large, households, and individuals need credit for all their needs. People may need credit due to an emergency, to purchase something at short notice, or to cover a shortage of cash. But to get credit, you need a credit score.
In simple words, a credit score measures your creditworthiness. A credit score is the first thing banks or lenders check when looking at a loan or credit card application.
Credit scores range from 300 to 900. Ideally, banks or lenders consider anything above 750 a good score, indicating the borrower’s good credit behaviour or ability to repay a loan.
Banks don’t calculate credit scores. It is evaluated by the four credit bureaus operating in India—CIBIL, CRIF, Experian and Equifax—who consider many factors like payment behaviour, credit mix, exposure and credit history. A low credit score is a roadblock to your purchasing power and future loans.
Let’s dive in and learn about the importance of credit scores and the concepts surrounding credit.
What is Credit?
The concept of borrowing money relies on a promise made by the borrower to return the debt at a particular date or time. The term credit was coined to define the relationship between a borrower and a lender.
Many people think that credit is an agreement or a pact between both parties (lender and borrower) with the promise to pay later. It can also mean a person’s ability to pay off debt with interest.
Always remember that:
- Often, credit is also called credit history or creditworthiness
- Credit can either increase liabilities or decrease assets
But is credit similar to a loan?
A credit is a specific amount of money given to customers by banks and other lending institutions. There’s always a spending cap on the credit. Whereas, in a loan, the banks or lenders sanction a large amount of money that can be used at any time.
What is the Role of a Credit Score?
As mentioned above, a credit score is the first thing a bank checks before handing out or sanctioning any loan or credit card. A credit score is your reliability number. The higher. The better.
Banks assess your credit score and report to take a final call on your loan application.
If your credit score is less than 600, then your application will likely be denied. Don’t worry. We will also discuss ways you can improve your credit score later.
A good credit score also means better loan interest rates from banks. A lower score means higher monthly EMIs.
How is Credit Score Calculated?
The credit bureaus are responsible for calculating the credit score. Each bureau has its methods to calculate credit scores. Factors like payment history, credit utilisation, credit mix and type are considered to get a credit score.
- Payment history is the key factor that credit bureaus track and record, which later reflects in your credit score.
- Credit utilisation ratio also impacts your credit score.
- Every time you apply for a new loan or top-up an existing loan, your credit score gets impacted based on the inquiries.
What are the advantages of a good credit score?
- Better loan interest rates and lower EMIs
- Easier access to loans during emergencies or in the future
- Credit cards with better offers and rewards
- Access to pre-approved loans
- Banks will offer loans for a longer term
- Fast loan approvals
- Better negotiation power than people with less credit score
People with better credit scores have a long credit history. Achieving a good credit score requires a lot of patience, discipline, and building a set of good habits. Building a good credit score requires persistence. That being said, the key is to be a wise spender.
How to Improve Your Credit Score In 2024
It’s okay to have an imperfect score.Having a low credit score is not the end of the world. It’s possible to increase your credit score by being smart and disciplined. The important thing is to be optimistic and not get discouraged.
Build healthy habits
Clear your debts – This may sound obvious, but it’s important. It doesn’t matter how small the amount is. They will pile up, reflecting poorly on your credit score.
Keep your credit utilisation under control – Never go overboard with using all the credit that’s available to you. Ensure that your credit utilisation is always low especially when it comes to your credit cards.
Keep your credit card accounts open – Keep them open, even if you aren’t using them. To achieve your dream score, always keep your older accounts active because the older the accounts, the more it adds to your overall credit health.
Plan your retirement early – Your savings will help you lower your credit utilisation. This is because retirement plan loans aren’t reported to credit bureaus. They are deducted from your salary.
Reduce your debt-to-income ratio – Your debt-to-income ratio is the amount of debt you have versus your current income—the lesser the ratio, the higher your score. To get the number, combine your monthly loan payments and divide the sum by your gross monthly income.
Check for errors in your credit report
Did your credit score drop after paying off a loan? Chances are that you might have some errors in your credit report, and it’s your responsibility to fix these issues.
You can always request free copies of your credit score report or simply download it here. Carefully review your report and check for mistakes–purchasing errors, unpaid dues, or overlapping entries for a similar product or service.
Buy things that appreciate in value
Buying clothes, booking a vacation, spending on gadgets, etc., can be tempting if you have a credit card. And sometimes, we forget to clear those dues on time. The interest keeps piling up, and we end up paying more than the actual price.
Hence, spending your credit on things whose value doesn’t depreciate is wise. This way, you will never pay more, keep your credit utilisation under control and spend wisely.
Go for the credit limit hike
If you get a call from your bank about a credit limit hike, please don’t hang up. Say yes as credit is like an emergency fund. The higher the limit, the more confident you will be about facing unforeseen situations. Just don’t shop till you drop and forget about the dues.
Talk to your bank if things aren’t going well
Mistakes happen. Sometimes people with perfect scores miss deadlines or succumb to certain situations that can leave a black mark against their credit history.
However, you can always make that go away if you communicate your issue with the lender. Explain your situation, make a solid case in your defence and ask for goodwill adjustments.
Set reminders for EMI payments
Nobody’s memory is perfect & if you’ve got plenty of bills, it’s easy to forget your loan EMIs. That’s why it’s smart to set up payment reminders for all your loan repayments. Simply add it to your calendar app on your phone.
Customize your loan tenures
If you’re worried about paying large sums every month in EMIs, customize your loan tenures so that you pay smaller EMI amounts for a longer duration of time. This reduces the risk of you skipping an EMI payment because of a lack of funds.
Build a credit history
One of the most effective ways to build a strong credit score is by taking different forms of credit and repaying them on time. This tells the bureaus that you are responsible and therefore, of low risk.
Bottom Line
At the end of the day, your credit score is a useful tool not only for the credit bureaus to judge your financial profile but also for you to figure out how to build a healthier financial lifestyle. Credit is by all means a useful tool but it’s one that should be used judiciously.
