Primer: Understanding credit scores
Credit score is a numerical value derived from the credit history of a customer over a period of time. Credit bureaus use their own parameters for time for deriving scores and the time period can vary from few months to couple of years.
The significance of score lies in the fact that it gives an idea about the probability of default / delinquency of a customer. For a lender, the score is an effective tool to judge the customer’s credit performance and sanction loan based on that.
Needless to say that higher the score of a customer, the better it is for the customer. India’s leading credit bureau CIBIL uses a score range of 300 to 900 in which 300 is considered as the lowest score while 900 is an optimal or an ideal score. Equi fax, another credit bureau in India, uses a score range of 1 to 999.
The credit scores are very important for a customer in an era when people need credit to meet requirements such as house, cars, education loan etc.
What are factors that decide the score of a customer? There are various factors that contribute to the score that an individual gets. These factors can be described as follows:
Past credit performance: The most important factor that drives score of a customer is the credit performance in the past. If a customer has a consistent credit history with no delayed payment or default, the score is bound to be high.
This means that in order to build a good credit score, a customer should never delay payment of loans. Any significant delinquency or default can mar credit score of a customer. For those customers who have no credit history, the credit bureaus do not generally assign a score.
Credit Mix: Credit mix means the combination of secured and unsecured credit that a customer has availed. Unsecured credits are risky but customers who pay regularly on unsecured credits get a better score. The reason for this is obvious. A customer showing commitment on unsecured credit is more reliable than a customer showing commitment on secured credit.
Demographic factors: Credit bureaus in India use demographic factors such as age of an individual, address detail of the customer etc. to create credit score to the customer. However, it is important to note that these factors do not have significant bearing on the credit score of a customer and if a customer pays regularly on his loan the credit score will continue to be high.
Other Factors: There are various other factors which make impact on the credit score such as usage of credit card, the number of inquiries made on the customer in the credit bureau, usage of credit facilities etc.
In brief, various factors impact credit score of a customer. However, the most important factor for a customer to remember is that timely payment of loans helps in building a healthy credit history and credit score.
The author has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance.