Past performance is no guarantee for future returns,” is a standard disclaimer used by most mutual funds and insurance companies. But when it comes to your personal finances, your past financial history is a good benchmark of how well you will be treated by lenders.
This is the time of the year when the maximum delinquencies happen on credit score sheets. Juggling between repayments of loans, tax cuts on salaries and renewals of financial policies often prove tough for families. It is a difficult choice, but as credit information companies such as Credit Bureau of India Ltd (CIBIL) would tell you, slipping on credit card and monthly instalments can prove fatal for your ratings.
As credit history plays an increasingly important role in your future transactions it is important to remember which elements in those to keep in shape to make banks look happily at your next loan or credit card appraisal.
Credit history is a snapshot of your past and current credit relationships such as names of banks and financial institutions that have given you loans in the past, the nature, ownership and status of these loans — basically how the figures sum you up. The data is compiled by credit information companies and used by banks and even non-banking financial institutions to create your profile that will determine your interest rates on just about everything. And since those rates, as per a PwC study on finance, accounts for how you spend more than half of your salary, it makes sense to take time to iron out the creases on the credit scores. Their role is expanding. Now going beyond insurers, even telecom companies are using this data to sell products.
So along with CIBIL, Equifax Credit Information Services and Experian Credit Information Company have risen in importance for the economy and for all of us. And yes, they have the legal and regulatory backing to access information from their member banks and assign credit scores to individuals to map their risk profiles.
“Earlier while the banks used to give loans to entities with a score of 600 out of 900 in the CIBIL profile rating, now they mostly prefer a higher rating of around 800,” said Arun Thukral, managing director, Credit Information Bureau of India Limited (CIBIL).
While credit scores are used widely by lenders in countries like the United States for processing loan applications, in India too, banks have become increasingly wary following the 2008 global financial crisis that had its origins in bad housing loans. Further, the tight liquidity conditions in the country over the past one year have made banks more cautious and choosy in giving out loans.
Every credit information company has its own method of calculating credit risk and hence would give a different score. For instance, CIBIL provides credit scores ranging between 300 and 900 to individual consumers by compiling details of bank accounts, loans, credit cards. It considers a score of 700 as essential for getting a loan, but warns that factors such as how recently and frequently a customer has defaulted on a loan payment also plays a role in a credit score.
The score is used as a gauge by lenders to assess an applicant’s risk profile while processing a loan or credit card application. It has also started to provide a risk index between one (high risk) and five (low risk) for individuals with less than six months of credit history.
Apart from the credit report, banks also use other criteria such as employment, income, age and residential address of a potential borrower before approving a loan application. Thakral says that earlier it was largely private sector and foreign banks that reviewed credit history before deciding on loan applications but now even public sector banks have begun to make such enquiries. In fact, the country’s largest lenders — State Bank of India — now also regularly seeks credit information from CIBIL.
How it works
Typically, credit information firms have a network of member banks and financial institutions, that send transaction details to it regularly — in some cases credit card companies send it on a cycle basis, while banks prefer to send the data on a monthly basis.
Credit information companies then use the data to create financial histories of consumers, which can be tapped into by member banks. Individuals too can access their credit reports by logging on to the website of these firms and ordering their report that comes at a nominal fee ranging from Rs 148 to Rs 470.
In case of any errors in their reports, individuals can write to the credit information companies to get it rectified. Under law, banks are given a 30-day timeframe to correct their records. But the main objective behind allowing individual consumers to tap into their credit reports is to enable them to understand their own financial history and work on areas of improvement. And given time and effort, it is possible for anyone to enhance their credit score and polish up their credit report.
How to improve your Credit Score
Be punctual: Always, always pay your loan EMIs on time. If you have more than one loan, maintain a calendar of the due date for each payment and if possible, consolidate all loans in a single account. This will ensure that the payment process becomes easier for you.
Be prudent: Never lag behind on credit card payments as it is a revolving credit and is sharply reflected on your credit score. It is always best to make full payments on your credit card each time, but if you are running short of cash in a particular month, do ensure to pay the minimum due. Also if you have two credit cards, instead of using the maximum limit in one card, try to break it down and use both cards equally for payments.
Be practical: Don’t apply for credit cards or loans if you don’t need to, as it means increasing your credit exposure. Also, always remember — more credit cards means you have more room to spend even if you do not have the means to repay back the debt.
Be a planner: Keep a tab on your savings. At times, it is better to pay back outstanding loans by using up some of your savings than paying interest on the debt. Not only does it mean a better credit score, but in the end you also save more as the interest component on loans is usually much higher than what you earn by keeping cash in your savings account or in a fixed deposit.