How Your Credit Score Works?

Due to apply for a home loan or mortgage? Make sure to keep your CIBIL report handy. If you already didn’t know, this report is more than just a document in the loan approval process. The summary of this report, or the 3-digit number, could be your passport to a smooth loan approval process or a blocker to your home-buying aspirations.

So, it is important to know the different wires that connect and light up your CIBIL score, because that’s exactly what lenders will see in the score: red, indicating high-risk borrower; yellow, indicating there is still some risk in lending you money; or green, indicating it is safe to lend you money.

Don’t we all want to remain in the green zone? So, here’s the lowdown on how your credit score works.

Components of your Credit Score

A CIBIL score ranges from 300 to 900. The moment you avail of any credit from a bank or a lending institution, you activate your credit history. What this means is you start leaving footprints of your credit handling behaviour and each of these footprints is a data point that feeds into the final number that is your credit score.

Weightage is given to different aspects of your financial behaviour. The score is generally calculated based on the following factors;Credit Score Components Weightages Important Factors pic

Repayment History  (Past Performance) : The largest component of the score is your ‘Repayment History’. If you have never defaulted on a credit card payment or a prior loan, you have scored well in this aspect of your CIBIL report. This accounts for nearly 30% of the score.

Type of Loan (Credit Mix) : Type The next in priority is the ratio of secured to unsecured loans taken in your name and the length of your credit history, which accounts for 25% of the score. The higher the number of secured loans, like home, education or auto loans in comparison to credit cards or personal loans, the higher you score on this aspect.

Credit Exposure : Next, 25% of the pie is accorded to your credit exposure – meaning the amount of credit that has been given to you. Too much of credit exposure over a short period of time may mean that you are given to live beyond your income level and this can affect your score poorly.

Other Factors : The rest of the 20% is a combination of a number of smaller, but, important factors, such as credit utilization, length of credit history and recent credit paying behaviour.

That, in short, is how your score is calculated. The next question, then, is, what use does this score have to banks and lending institutions? It is used to filter out the credit(un)worthy from the creditworthy lot of applicants.

If your score is 750 – 900, you are considered more eligible for a loan. While the lending practice in developed countries includes considering the score to offer better home loan rates, it is not the same in India. RBI regulations do not allow for much deviation of such rates. So, then, your CIBIL report helps build your credibility to lenders and makes access to such loans easier.

It goes without saying that a loan for a low CIBIL score is difficult, if not impossible. Top public and private sector banks would find it difficult to justify lending money to a person with a lower score, because it reflects badly on the person’s ability to clear debts.

However, it is important to remember that your score today will not be the same tomorrow. It is dynamic and responds to corrective measures to improve CIBIL score.

One such fundamental step is to identify whether or not the credit report is accurate or not and know how to correct a CIBIL report. Scan your report thoroughly and look for errors in lines of credit. It could be a certain transaction is reported erroneously, or, a loan made out in your name is not yours at all. Errors in identity switching are not new and you need to be alert in identifying and correcting them.

Next, check to see whether you have the current score. As already mentioned, the credit summary is dynamic and changes with your credit behaviour. Could it be that the last EMI or credit card payment is not reflecting in your score? CIBIL updates them monthly, so, be sure that you have the most up-to-date score.

Your CIBIL report is an important factor in creating the right image of you to banks that you approach for loans. Just as your current income is one part of this image, your credit summary is the other half of this image. Stay on the safe side – keep the light green – by ensuring your CIBIL report does not play an image spoiler.

This guest post is authored by  Arun Ramamurthy.

About the Author

Arun - Credit Sudhaar

Arun is an IIM alumnus with work experience at leading global banks in India. He is the co-founder of Credit Sudhaar, a company which aims to spread awareness about importance of credit health and help people achieve their financial objectives.

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Kindly note that is not associated with Credit Sudhaar. This post is for information purposes only. This is a guest post and NOT a sponsored one. We have not received any monetary benefit for publishing this article.

(Image courtesy of Stuart Miles at (Post Published on : 20-May-2016)

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  • Vinayak Telkar says:

    How a individual can check his/her credit score?

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