Here's how banks view your credit rating

Having a low credit rating can lead to unfortunate situations, when you are least expecting it. If you are gearing up to purchase a house, a car or two wheeler, a big screen TV, apply for a personal or even a lifestyle family holiday loan, and, you realise that owing to your low credit rating, the deal falls through, your world comes crumbling down.

More so, imagine this coming at a time, when you are all but ready to buy that dream house or your very first car. Not only a lender, but even a prospective employer can turn you down, landlords can refuse you a lease or your insurer can raise your premium based on your rating. A healthy credit rating is crucial to your decision to avail the loan. Therefore, it becomes imperative to demystify credit ratings and understand how financiers view your credit rating and more importantly, how can you maintain a healthy rating.

In all developed markets, there are credit rating agencies or credit bureaus who assign credit rating or credit scoring to each Individual or entity which acts as an enabler for the financier to take a credit decision. At present, there are four credit rating agencies which provide ratings for Individuals viz. Cibil, Experian, Equifax and CRIF High Mark who evaluate each individual and assign a score from 0-900 band with 900 being the best performer.

The credit rating report as published by the credit bureau is an aggregation of the different types of credit / loan facilities that you have availed in your lifetime and acts as an evaluation of your ability as an individual or an organisation's to fulfill the financial commitments. The global financial crisis of 2008-2009 forced the lenders / financiers to acknowledge the importance of credit history and profiling. Thereafter, credit history or rating has been an integral part of the decision making process for the financiers. This report contains demographic details and the customer credit history of each loan, number of loans applied, behaviour pattern and so on. In general, a credit score of over 750 (of a total of 900) is considered as a safe number for availing any loan facility. A higher score has a better approval rate as seen in the industry graph of the past year's bookings, with scores of 800+ and 750-800 score band having approval rates of 52% and 33% as compared to the single digit approval rates in the lower score bands.

The following information affects your payment history:

Payment history: The record of on time payments made to the lender reflects the 'willingness' or 'character' of the applicant towards repaying the loan. Late payments or any 'derogatory' history like delinquencies or lawsuits will lead to a lower score. For example, if you make a credit-card payment 30 days after your payment due date, your score could drop by as much as 75 points. A drop from a high score of 750 to an OK score of 675 could at the best add an additional cost to your loans or in a worst case scenario, you may be denied further credit as well as see a decrease in your existing card limit.

Credit utilisation: This indicates the extent to which the applicant has utilised his limits. A higher balance and utilisation level indicates that an applicant is overextended.

Length of credit history: 'Best credit is old credit'. A longer credit history, especially a good repayment history gives that extra comfort of worthiness to financiers. On the other hand, for applicants with a very low credit history, the weightage on capacity and capital does increase significantly while making a decision.

Therefore, the 'payment history' and 'credit utilisation' are very critical and are significant in deciding the credit worthiness of an applicant.

How do financiers decide the loan approval?

A common credit evaluation framework used by financiers is the 5Cs: Character or credit history of the borrower, capacity to repay, collateral or asset being finance, capital or margin money and conditions of approval. A lender will carry out many checks to ascertain the obligation of a borrower to repay the loan. This includes field visit confirmation, education background, quality of references, and type of establishment, lifestyle comfort and number of dependents. In cases where the income is not verifiable, financiers use alternative data like bank statements and lifestyle assessment to determine the income levels.

Some financiers also use social media attributes like activity on Facebook, designation and employment detail verification on LinkedIn coupled with a scoring model to help underwriters take quick decisions.

What can you do?

Knowing your personal credit score before you apply for credit can save you time and money and help you in planning your financial future. Lenders not only use your score to determine when and if you will receive credit, but also use your score to determine the borrowing terms of your loan.

Know your credit standing

The Reserve Bank of India has made it mandatory for credit information companies to provide one base level consumer credit information report, free of cost every year from January 1, 2017. This is aimed towards propagating awareness on the importance of a healthy credit history thereby instilling discipline in individuals and organisations so that the finances can be managed prudently.

Understand your credit potential

Credit facilitator sites (like CreditMantri, CreditSeva) enable users to access their credit score and history, helping further build their credit profiles in order to know their credit potential.

The writer is senior group president, retail and business banking, YES Bank