How To Improve Your Credit Score

What Is A Credit Score? What Is A Credit Report?

In simplest terms, a person’s credit score is a three-digit number representing their financial well-being. It is calculated based on an analysis of their financial history and can be anything between 300 and 900. The credit score can change over a period of time depending on the borrower’s financial liabilities and associated behaviours.

Since a borrower’s credit score is a purely numerical snapshot of their credit history, it does not provide lenders with any additional information about them. This is where a credit report comes in. A credit report is a comprehensive holistic statement that provides detailed information about a borrower, such as the number of accounts, history of debt repayments, the status of loans, defaults (if any), current balances, PAN number, date of birth, etc. The credit report also includes the credit score.

The historical information that is used to prepare a borrower’s credit report and calculate their credit score is sourced from their credit records. These records are submitted by his/her lenders to the credit bureau, which then utilises multiple factors to arrive at the credit score.

In India, 4 RBI-approved institutions calculate credit scores and provide credit reports: CIBIL (Credit Information Bureau India Limited), Experian, Equifax and CRIF High Mark. Although all bureaus provide accurate information, most Indian banks and financial institutions usually refer to CIBIL’s data to determine a person’s eligibility for a loan or a credit card. CIBIL’s report is also known as a Credit Information Report (CIR).

Together, a credit score and credit report represent a person’s past and current financial health. This helps lenders forecast their likely future financial behaviour and thus make decisions about approving or rejecting their credit applications.

How Is Credit Score Calculated?

Credit bureaus like CIBIL utilise a number of input factors and a complex credit scoring algorithm to calculate a borrower’s credit score. These factors include:-

• Credit history and repayment track record (on time/delayed) – this alone has a weight of 30% in determining the final score
• Credit utilisation history – this has a weight of 25% in the credit report
• Available credit balance
• Number of accounts – both loans and credit cards
• Credit mix and duration – the balance between secured and unsecured loans
• Number of credit applications in the recent past

Once the above pieces of information are available, the credit bureau collates them into an individual’s credit report and calculates their credit score. For each individual, the credit bureau keeps a monthly record of the latest 3 years of bill and loan repayments.

What Is A ‘Good’ Credit Score? Why Does It Matter?

A borrower’s credit score is considered good if it is as high as possible. This is because a good/high credit score indicates a more ‘creditworthy’ borrower. This has implications for lenders such as banks because a higher number implies a lower risk of default, which in turn makes borrowers appear more trustworthy. This makes it more likely that their loan or credit card application would be approved.

In India, a borrower’s credit score could be anything from 300 – 900 but only a score over 750 is considered good. Anything under 750 makes them appear risky and therefore unlikely to be extended credit through cards or loans.

With a good credit score, a borrower could get new loans at ‘preferred’ (lower) interest rates or a new credit card with higher credit limits. Other benefits are also available to borrowers with scores over 750, including:

• Higher loan amounts sanctioned
• Faster approval process for both loans and credit cards
• Longer repayment periods

Apart from loans and credit cards, a good credit score may also play a role when a borrower:

• Applies for a job – some potential employers may ask for credit scores to judge an applicant’s financial conscientiousness, especially in sensitive financial or compliance-related roles.
• Buys insurance – insurance firms may check credit scores to determine a borrower’s premium payment capacity before approving their insurance application.
• Rents a living space – some landlords may request credit agencies for credit scores to assess if the renter can be trusted to make future rental payments. Currently, this is not a common practice in India, but the situation may change in the future as the country becomes a more credit-based/cashless economy.

What Factors Can Adversely Affect A Credit Score?

A number of factors can negatively impact a borrower’s credit score which can make them appear less creditworthy and thus affect their access to credit in the long term.

• Late repayment of debt – both loans and credit cards
• Defaults on debt
• High utilisation of credit card limits
• Too much total debt or a high percentage of unsecured debt in the debt basket
• Too many credit enquiries – even if the enquiries are made by potential lenders
• Settling debts instead of repaying them
  • Other ‘negative status’ accounts such as written-off/suit filed/account sold can also negatively affect a person’s credit history and consequently their credit score
  • Default on loans where the individual is not the primary borrower, but a joint holder, co-signee or guarantor

Read the next section to learn how to mitigate the effects of these factors on your credit score.

How Can I Improve My Credit Score?

As the world becomes less cash-based and more credit-based, it is becoming more and more crucial for individuals to maintain a good credit score. A poor score could deprive a borrower of much-needed financial help in the form of loans (personal/home/education/car), credit cards and even insurance. Therefore, it is incumbent upon individuals to maintain a good credit score or repair a poor one.

With careful planning and discipline, it is possible for a person to improve their credit score within 6 to 12 months (maybe even sooner), depending on their financial situation and wherewithal. Here are a few ways you can do this:

1. Be Proactive & Review Your Credit History Regularly

Your credit report could have errors that may be dragging your credit score down for no good reason. Or instead of errors, your low score could be a result of missing information such as recent payments that your lender has not yet reported to the bureau. Your low score may also be the result of fraud – a credit card or loan that you did not apply for, but still shows up in the report. Therefore, the first step in repairing your poor credit score is to obtain your credit report and check it carefully for errors and missing/fraudulent data. If you do find issues, you can file a dispute with the bureau, which will automatically increase your credit score. To obtain your CIBIL report and file for any disputes, you must first sign up to be a CIBIL member.

2. Pay Your Bills On Time & Manage Your Debt Effectively

Your repayment track record determines a third of your credit score. Therefore, repaying your loan instalments (EMIs) and credit card bills on or before their due dates is critical. Even a single delayed, or worse, a missed payment can accumulate unhealthy debt in your account which will bring your score down considerably. Also, remember to pay in full because repaying only part of the amount due or the minimum amount due will result in further interest liabilities and have an adverse effect on your credit score. Finally, do not opt for one-time settlements even if you get a steep discount. If you settle your dues through a single repayment instead of via regular repayments, your credit report will show the debt as ‘settled’ which will bring your score down considerably.

All these negative facts can stay on your records for a few years so keeping your reports ‘clean’ through regular repayments is very important.

The Bottomline: Pay on time, pay in full, pay every time.

3. Limit Your Credit Card Spending

In addition to the points mentioned above, don’t use your credit card for things that you may not be able to pay off on time and in full every month. This is the best way to ensure that you have fewer bills to pay in the first place! Avoid impulse purchases, postpone non-urgent expenses and most importantly, don’t be tempted by the availability of ‘easy’ credit.

Also, don’t use more than 30-40% of your available credit limit. Utilising close to 100% or even more than 50% of what’s available not only makes you appear credit-hungry and too risky to lenders, but also negatively impacts your credit score.

4. Avoid Applying For Multiple Credit Cards Or Loans At The Same Time

If you already have a poor credit score, you should avoid applying for more loans or credit cards with other lenders, for two reasons. One is that multiple applications within a short period of time signify that you are hungry for credit. Setting such a precedent makes lenders uneasy about your ability to repay, so they may reject your application. Each such rejection makes you appear riskier/less trustworthy, which then decreases your score even more. Another reason to avoid multiple debt applications is that every lender will request CIBIL for the borrower’s credit score before approving an application made to them. As more such inquiries go to CIBIL for the same borrower, his score tends to get lower and lower.

5. Maintain A Healthy Mix Of Credit

It is important to keep a balance between secured and unsecured loans to maintain a good credit score. Secured loans such as home loans build a ‘long-term appreciating asset’ which is considered a good thing and therefore improves your CIBIL score. On the other hand, unsecured personal loans or credit card debt build no tangible asset and can have a negative impact on your score, especially if not paid on time and in full.

6. Think Twice Before Signing Up As A Co-Signer, Joint Account Holder Or Guarantor

If you are a co-signer, joint holder or guarantor on a loan account, and the primary borrower defaults on the loan, you will be held equally liable for repayment by the lender. This will show up on your credit report as a red flag and bring your score down, unless you pay the amounts due yourself (assuming the defaulter never will).

Final Thoughts

While money may make the world go round, it is credit that keeps economic engines running. At some point in their life, everyone needs credit. For individuals, credit impacts a number of aspects of daily life and a poor score translates into limited access to credit. Therefore, it is absolutely critical to keep building one’s credit score and maintain it at a healthy level.