Yes, because despite existence for over 2 decades (the bureau was set up in 2000) and has over 600 million individuals’ and 32 million business records, a larger population of those even present on the bureau record do not understand anything about this three figure numerical expression about their credibility. Not only do they have a challenge on the broad understanding of the score but the concern is about not having to understand their importance and the impact that these scores can have on their financial lives.
No, because it is fairly simple to understand these scores. Notwithstanding the fact that the algorithms applied to arrive at these scores are complex, but one can for sure get insights into the broad requirements and factors that influence them.
To give better clarity to both sets of people (with and without much understanding on the credit scores), I am segmenting this post into three categories.
Score Range of 300 - 900
Each individual is assigned a score between the range of 300 to 900. The accessibility to credit from formal banks and lending institutions gets impacted by these numbers. A higher score denotes to better credit risk profile. The risk profile becomes increasingly higher with diminution of the scores.
The following illustration will give you a quick idea on how the scores are perceived in relation to your credibility with the lending institutions.
The following are the key highlights of the above illustration:
Any query on the threshold of a good credit score will generally get responded to with an answer of 750. It means that if someone is looking at deriving benefit, both in terms of availability and cost of credit, one must have a score equal to or greater than 750.
Score Range of 1 – 5
There is a different score range for all those who have a credit history of less than 6 months. A higher number will reflect a better credit profile.
Before we move on to the next segment, would like to touch upon this important information. Following four bureaus operate in India
The question may arise that why do we need these many bureaus when just one or two would have been enough to give lending institutions the tooth to deal with defaulters. First, not process can be monopolistic, and second, these are the largest bureaus and their presence in India is just logical.
Let me now briefly explain to you the factors that impact the credit score. This will definitely facilitate you in having an understanding of what goes into the calculation of this numerical expression of your credit profile.
FICO score calculation is one of the leading score calculation processes and is being used by a large number of credit bureaus. The following illustration will help you understand the five broad parameters that are used by FICO to calculate the credit score for any individual.
The following are the key highlights of the above illustration:
CIBIL TransUnion has given a new definition to these parameters and as per an article published by the bureau’s official the score calculation is as follows:
The following are the key highlights of the above illustration:
So one can conclude that to have a good credit score:
I would like to explain this complex phenomenon with much simplicity by covering it in two parts.
First, the banking business itself. Banking is a complicated and risky business. But it still can be defined as the model that borrows money at a lower price point and further lends it at a higher price point. The margins between the two ends of the spectrum are used to meet both expenses and profits. The banks or any lending institution cannot afford non-repayment from the borrower. So all lenders would want to extend loans or any other credit facility to better paymasters.
Second, we live in a hyper competitive world today. While one may not realize it, the fact is that even banks have competition. Each one of them would want to have a good repayment master on their books. End of the day, it is through the lending products’ repayment that the banks make money.
Considering both the above points, one thing that becomes crystal clear is that the banks would want to have a better customer base. And to assess this nothing can be better than the credit score. So a prospective borrower with a higher credit score (deemed to be a better paymaster) can be offered a lower rate of interest. Since the underwriting of any loan is about mitigating the risk, the borrower with higher risk is bound to get charged a higher interest rate in comparison to one with lower risk.
Let us understand this better through an example.
Two of your knowns approach you for some financial assistance. One of them is placed at a senior position while the other one is struggling with consecutive job losses over the last couple of years. Considering that you do have money to support both of them, but who is the one whom you would be willing to extend a loan to?
Also Read- Factors Influencing the CIBIL Score
Does this question really needs to be answered? While it may not, what if you were to consider lending to both. The latter since would not qualify your comfort parameter for getting repaid in time, you may want to safeguard by asking few others if you should extend money or you may want to keep some collateral to safeguard your hard earned money.
The same is the case with the lending institutions as well.
The banks reward the individuals through a better rate of interest and keep them motivated to continue their repayment streak impeccable. Goes without saying that even a small difference in the interest rates can make a huge difference in the cost of funds and can result in savings of lakhs of rupees in interest alone.
Credit Scores are a fact of life and our financial life gets grossly impacted with this three number expression. One’s capability to raise funds at the time of need and at a competitive price is based on these scores. Therefore it is imperative for one and all to be as careful about the credit health as one would be about the physical wellbeing.
https://www.ndtv.com/business/how-is-your-cibil-score-calculated-773854