Financial concepts are sometimes hard to understand. Do you find your credit score confusing too? If yes, you are not alone. In recent years the importance of credit score has increased manifolds. It has become the most important measure that banks use to make loan approval decisions. But a common man finds it hard to comprehend what goes into CIBIL score calculation and how it affects him.
While most people know that a bad credit score can prevent them from qualifying for a loan or credit cards, beyond this information there is a lot of confusion. What is the difference between the credit score and report? What score is good enough for you to get loan approvals? What should you do to improve your score? How does credit card usage affect credit score? Questions like these may baffle you.
Let’s throw some light on these concepts so that your credit score no longer puzzles you.
Credit score and credit report are two different things
A credit report contains some basic personal information and summary of all your credit accounts- your balances, how you make payments, how much credit is extended to you vs how much you have charged on the credit card, age of the accounts etc.
A credit score is a numerical figure calculated on the basis of the information in your credit report. The credit bureaus have a credit scoring algorithm for CIBIL score calculation. They give different weightage to different aspects of the report and accordingly arrive at a score that reflects the credit risk associated with lending you money. Lenders check this score to form a quick impression of whether you are worthy of lending money or issuing a credit card. A credit score is thus a reflection of your credit behaviour and a means of interpreting what’s there on your report.
There is more than one credit score
There are four major credit bureaus in India that maintain your credit related information. Each bureau has its own report and a credit scoring algorithm for arriving at the score. So different bureaus may arrive at a slightly different figure based on the weightage they give to different aspects of your credit information. So the score that you check yourself from one bureau might be different from what your lenders see, if they use your score from a different bureau.
Credit card usage is necessary to improve score, but carrying a balance isn’t necessary
Unused credit cards will not help in improving the scores. You will need to charge expenses and keep them active. But that does not mean that you need to carry a balance on your credit card to show that you can handle debt responsibly. It is not at all required to improve credit score. You need not pay any interest. Just charge small expenses on the card and keep it active. In fact paying the balance in full at the end of the billing cycle is a sign of healthy credit behaviour.
Factors that affect credit score
The two factors that have the highest impact on the credit score are the payment history and credit utilization. A history of on time payments on past loans suggests that a person is responsible in handling debts. It increases one’s credibility and gives a boost to the score. Similarly, a person who does not use more than 30% of available credit limit suggests that he does not rely too much on credit. Such a person will most likely repay the loans responsibly and hence has a good credit score. A good experience in handling both revolving and installment accounts and a long history of managing credit also demonstrates your creditworthiness to lenders and hence affects your score positively. Late payments, maxing out your credit card limit, and too many hard enquiries pose a risk to the lenders and therefore affect your score negatively.
Whenever your credit report is updated with new information your newly calculated credit score will change. Healthy credit habits will ensure a good credit score in the long run.