Thursday, 1 February 2018

Where Does Credit Score Come From?

Raj Is happily working in an organization with a position of Manager. His CTC is 8 Lakh per anum. He is 28 and planning to get married. Of all these years of work, he has managed to save enough money for the marriage of his choice. However, he is thinking to buy a house so as to make life smooth. He has heard people taking a loan, but he has never applied for one. So he thought of going through the whole process and getting to know the requirement for a loan. Of all the places he went, one same thing he heard was : “Credit Score”. And he was clueless, What is the credit score?
What is the credit score?
The credit score is a 3 digit number based on the analysis of how responsible a person is in his payments (say of credit cards or loans). It shows the creditworthiness of an individual.
Too many words which you do not understand? Let us uncomplicated :
  • So, basically credit score is number ranging from 300-900.
  • Now the question is : How is this score calculated? And how is this score made?
  • A credit score is calculated by the way you handle your finance responsibly. Your credit card repayments and your loan repayment are the major criteria of how your score is calculated.
  • How is score made? It is an algorithm which consists of the following aspects
  1. Payment History
  2. Outstanding Balance
  3. Account Age
  4. Types of Credits
  5. Inquiry
  • On these above mentioned 5 points different credit bureau, have different weightage and the algorithm to calculate the score.
What is a Credit Bureau ?
A credit bureau is an organization which takes the above mentioned information from the various financial institution like banks and NBFCs in order to show the credit maintenance behavior of an individual. CIBIL, Equifax, Experian and CRIF Highmark are 4 credit bureaus in India.
Let’s see now how is CIBIL score Calculation done.
Where does the score come from?
  1. Payment History :
                Payment history is the major attribute in any bureau to calculate the score. This is nothing but the detail which shows how responsible have you been in making your previous payments. Previous payments are not any of payments which you have done, but the credit repayments specifically. Credit repayments are mainly the credit card payments and the loan repayments. How regularly you make the payments, will determine if you are an asset to the lender or a liability.
  1. Outstanding balance :
                Outstanding balance is the second major factor in the credit score. Outstanding balance is the one which is still left by you to pay to the bank/NBFC. At times people make defaults and do not make the payments. This however, time to time keeps on increasing because of the interest rates associated with it. The more time passes, the more balance increases resulting in the nightmare of the score.
  1. Account Age :
                More the older account, better is its value. The account here is not a normal bank account what you maintain, but is an account of either a credit card or a loan taken. Older and more clear the account, better is the credit score associated with it.
  1. Types of Credits.
                There is very less weightage to this factor. But it is not the one which is to be ignored. Types of credit redirects to the meaning of the secured or unsecured type of credit which you have. Only secured credit if you have would make you look a non-risk taker and only unsecured would act as if you don’t have any asset in your hand. For a healthy report you need mix of both, secured and unsecured type of credit.
  1. Inquiry
                Every bureau offers one free credit report per year. So, for once if the inquiry is made, it is good. Now every time you apply for a loan, there is an inquiry made and also every-time you ask to fetch a report, an inquiry is made. More the inquiries in short span, more the creditors think you are credit hungry.
Now, Raj; With the future plans of taking a personal loan for his expenses or taking a home loan, to buy a house for the near future, he has the knowledge about how he can manage to keep the bar up of his credit score which will not only help him getting loan easily but also getting them at better interest rates.

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