Simplifying How Credit Bureaus Calculate Your Credit Score

Credit score. This term has been no less than a revolution in India¡¯s financial sector since the past decade or so. You might have come across tons of information and advice surrounding the importance and role of credit scores in our financial lives. More so, if you have taken or enquired about a loan or credit card. But amidst the flurry of information, we are dumped with when it comes to credit score advice, a lesser touched upon aspect is how credit bureaus actually calculate your credit score.

And with the new year 2022 knocking at our door, isn't this an opportune time to understand this crucial aspect of your financial life? After all, a credit score holds the potential to make or break your loan and credit card approval chances.

So read on as we help clear the air surrounding the concept of credit score and simplify how credit bureaus calculate your credit score.

What is a credit score?

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A credit score is a three-digit numerical representation of your credit history and generally ranges between 300-900. It depicts how well you have been handling your debt repayments on the basis of your past repayment behaviour towards your loan EMIs and credit card bills.

Also Read: Worth Explains-Why Credit Score Should Be A Millennial's Best Financial Buddy

How do credit bureaus compute your credit score?

Your credit score is computed by credit bureaus based on the information included in your credit report, which contains the summary of your current outstanding loans, past credit accounts and existing credit card balances, besides other credit-related information as well.

At present, there are 4 credit bureaus in India- CIBIL, Equifax, Experian and Crif Highmark. Although each of these four credit bureaus has its own scoring parameters and mechanism to compute credit score and assign weightage to the involved parameters, the key factors considered by bureaus, include- credit repayment history of loans and credit cards, credit mix, credit utilization ratio, age of credit history and credit enquiries.

Let¡¯s deep dive and understand these factors.

1. Repayment history of credit card bills and loan EMIs

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It's widely believed that repayment of your credit card bills and loan EMIs is given a significant weightage by bureaus when calculating your credit score. Making timely and full repayment of your credit card bills and loan EMIs helps in building a favourable credit history, which gradually builds up to a strong credit score.

Whereas on the flip side, any irregularity in credit card and loan repayments is capable of damaging your credit score, as such actions depict you as financially undisciplined.

Also, the loan accounts co-signed/guaranteed by you are also included in your credit report for computation of credit score, because co-signing/guaranteeing makes you equally liable for that loan¡¯s timely repayment. So, when the primary borrower delays or defaults, your credit score would be impacted too, along with that of the primary borrower. That's why it is advisable to regularly review the repayment activities of your co-signed or guaranteed loan accounts and ensure timely payments to prevent your credit score and future credit eligibility from getting harmed.

Also Read: Why Do Millennials Fall Into Credit Card Debt Trap?

2. Credit mix

Credit mix is the ratio of your unsecured (like personal loans and credit card) and secured debt (like home loans and car loans). As lenders usually prefer lending to those with a balanced credit mix of secured and unsecured loans in their portfolio, credit bureaus, too, tend to score such borrowers higher and more favourably. Whereas those with too many unsecured loans may be perceived negatively by the credit bureau and lenders, which may harm the credit score as well.

3. Credit utilization ratio

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This ratio is the proportion of your total credit card limit utilized by you. For example, if you have a total credit limit of ?1.5 lakh and your current outstanding credit card dues are ?75,00,0, your CUR comes out to be 50%. Note that, lenders generally consider a credit utilization ratio of over 30% as a sign of credit hungriness, which can be viewed as a higher likelihood of defaulting in future credit repayments. Hence, credit bureaus, too, tend to pull down your credit score by some points on breaching this 30% mark, which can cause significant damage to your credit score, especially if done frequently.

4. Credit enquiries

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Each and every time you submit a loan or credit card application, the lender fetches your credit report from the credit bureaus in order to evaluate your creditworthiness and past repayment behaviour. Such lender initiated credit report requests are listed as credit enquiries in your credit report, each of which can reduce your credit score by a few points. And in case you end up submitting multiple credit applications to lenders, especially in a short span of time, your credit score can suffer a dip.

So, it's better to spread out your applications across different time periods to avoid bombarding lenders with too many applications, and also try to research about eligibility and offers of various lenders and then zero in on submitting applications to the most prospective ones only.

5. Age of credit history

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Another factor often taken into consideration by credit bureaus when computing your credit score is the age/length of your credit history. Generally, the longer your credit history, the better it is for your credit score, as lenders and bureaus have a longer view of your credit repayment history. Credit bureaus usually tend to factor in the age of your oldest form of credit, whether a loan or credit card. For instance, you had taken your first loan or credit card 5 years back, so the age of your credit history would be 5 years.

Also Read: Why Your Credit Score Can Fall Despite Timely Payments!

How can you check your credit score?

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For checking your credit score, there are two ways. You can either fetch your credit report directly from the credit bureau¡¯s website or download it from online financial institutions and/or portals/apps offering the facility of downloading your free credit report.

As credit bureaus are mandated to provide one free credit report to customers at least once a year, you should ideally spread your credit report requests in such a manner that you are able to fetch one free report in each quarter of the year, from the 4 available bureaus.

Alternatively, some online financial marketplaces also offer the facility of free credit scores as well as credit reports every month.

Also Read: Tick Off This 5 Point Checklist Before Applying For Any Loan

How does credit score impact your loan and credit card approval chances?

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A credit score is used as one of the first filters to be factored in by lenders while evaluating your loan and credit card applications. It helps the lender, whether it's a bank, NBFC or fintech, to assess your creditworthiness through past repayment behaviour, which also indicates the degree of likelihood of you defaulting on the loan/credit card repayments in future.

A good credit score will depict you as more trustworthy, whereas a low or nil (absence of credit history, implying you have not taken any credit card or loan yet) credit score would make the lender take a cautious approach when deciding whether to accept or reject your application.

Besides all this, credit score¡¯s role has been gradually widening towards also being the basis for lenders to set your loan interest rates, as a part of risk-based pricing. In this practice, those having a higher credit score are likely to get a cheaper loan vis-a-vis someone having a poor or even nil credit score.

Does your loan or credit card application get rejected with a low or no credit score?

Although financial institutions generally tend to prefer lending to applicants having a credit score of 750 and above, having a low or no credit score is not always a dead end, as they might be offered loans at relatively higher interest rates vis-a-vis those offered to applicants with a high credit score. This higher interest rate is charged to cover for the presence of higher credit risk, i.e. risk of default, amongst those having low or no credit score. However, the final decision rests with the lender after factoring in not just the credit score but other facets like income, loan amount, age, existing debt obligations etc.

Also Read: 5 Super Financial Resolutions For New Year 2022

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