Monday, 13 February 2017

How credit bureaus calculate your credit score?

Before offering a new line of credit, be it a mortgage loan or a credit card the lenders evaluate your application based on your CIBIL score. The higher the score, the more confidence the credit institution will have in your ability to repay the loan. Hence a good score not only increases the chances of getting credit but also gives a greater bargaining power during interest rate negotiations.
In order to maintain a good credit score it is important to know how the credit bureaus calculate this score. In India there are three credit rating agencies CIBIL, Equifax and Experian who collect the borrower’s credit information records. The member banks, credit card companies and other formal lenders regularly send updates and status to the bureaus.  It includes all the information that is needed to build your credit profile, like details of all the loans you have taken, EMI and credit card payments, any late or missed payments, total credit limit, balance outstanding etc. They use advanced analytical techniques to assign a number ranging between 300 to 900; that reflects your financial health and gives a snapshot of your credit behaviour to the potential lenders. Each credit bureau has its own proprietary algorithm to calculate the score. However all the elements that affect the score revolve around the loan repayment behaviour of the individual. Different weightage is given to different aspects of your financial behaviour. Here is a quick glimpse into the factors that determines a person’s credit score.
Past repayment behaviour
The biggest factor that determines the credit score is the payment history. The credit bureau has a month-on-month record of all the payments that you have made towards EMIs and credit card bills. They have an up to date status of each account, whether you have made all past payments on time, after the due date or missed them. In order to score high on this aspect you need to make all the payments well within the due dates. Your name in loan defaulter list or delayed payments signals that you have trouble servicing your obligations and therefore affects the score negatively.
Credit utilization
Credit utilization is usually referred in case of credit cards. It is the outstanding balance on all your credit cards as a percentage of the total credit limit sanctioned to you on all cards. If the percentage of limit that you are utilizing is high then your credit profile is considered as risky. It affects the credit score negatively. In order to use this factor to your advantage make sure that you do not use more than 25% of the credit limit.
Credit Mix
The composition of your loan portfolio also determines your credit score. Lenders want to see whether you are able to handle different types of credit responsibly. Hence it will be good for your score if you have a mix of both secured and unsecured loans. If you have only a single type of credit like a credit card or a personal loan then you may not score high on this aspect even if you have made timely repayments. Mixing it with a secured debt like a home loan or a car loan will help you maintain a good score.
Other factors
Length of the credit history and number of credit applications made in the recent past are some other important factors that are also taken into consideration during the cibil score calculation. The longer the period for which you have been handling credit the better it is for the score. If you have made too many credit applications in the past then it portrays you as a credit hungry person and hurts your score negatively.

The mathematical formula used by the credit bureaus to calculate the credit score is not known to general public. However the above factors are the main elements that go into the constitution of your score. Taking care of these aspects will help in building your credibility. Timely payments of EMIs and credit card bills, low credit utilization and a mix of different types of credit accounts will strengthen your credit profile and fetch you a high credit score. A good score will ensure that you get loan approvals without any hassles and at the best interest rates. 

1 comment:

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