Many financial activities of individuals, businesses, corporations, and even governments revolve around credit. Credit is basically the lending of money by a financial institution to an individual, a business, or even a country. Since credit is so central to the workings of finances on both individual and larger scales, the terms 'credit rating' and 'credit score' are quite common and have been heard by everybody. However, many people are confused about the meaning and difference between the two terms.

Basically, both credit rating and credit score are ways lenders and investors use to assess the creditworthiness of a particular borrower or a firm, organisation, company, etc. When lenders give money to people, be it loans, credit cards, etc., they want to see how capable a person is of repaying the money. They obviously do not want to give out credit to high-risk applicants. Similarly, investors want to know how financially stable and successful a particular firm or company is before they invest in it. To judge the credit behaviour of individuals, banks and other lenders use what is known as the 'credit score. And to judge the financial stability of companies, firms, organisations, etc. investors use what is known as the 'credit rating'. Let us delve deeper and understand both the terms better.

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What is a Credit Score?

A credit score is a three-digit number that is assigned to all those individuals who have ever taken any form of credit from a bank or any other financial institution. This could be some form of a loan, mortgage, credit card, or something else. When you take credit, your handling of it is recorded. This includes things like how well and timely you repay the credit, how many times you have applied for credit, how many of those applications got approved or rejected, how much of your available credit you use, how much secured and unsecured credit you have taken, etc. These are also the factors that are taken into consideration when your credit score is being calculated. Different credit information companies use different algorithms and scoring models, but the final score of an individual will always fall somewhere within the range of 300 and 900. But who calculates this score? In India, the credit scores are calculated by four Credit Information Companies (CICs), also called India's credit bureaus. These are TransUnion CIBIL, Experian, Equifax and CRIF Highmark. Nobody else can calculate credit scores in India.

The credit score is part of a detailed credit report generated by these credit bureaus. It contains all your financial details related to credit. It is seen at the top right corner of the credit report and is like a numerical indicator of how good or bad your credit report is.

Now comes another question that you might have - why is credit score significant? Why does it matter?

Credit scores are important because they influence a lender's decision of whether to approve your credit application. Since credit scores reflect your past handling of available credit, lenders use them to see if it's risky or not to give you more money. A low credit score greatly reduces your chances of approval whereas a higher score means higher chances of getting your credit application approved. Credit scores also influence the type of terms and conditions you will have to face once you receive credit. It influences the amount of loans sanctioned, interest rates, loan tenure, credit limits, etc.

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What is Credit Rating?

Let us now understand what credit rating is. Just like credit scores are numerical indicators of an individual's creditworthiness based on their past credit behaviour, credit ratings are alphabetical indicators of how risky it could be to invest in a corporation or a business. In short, credit scores are for individuals and credit ratings or for corporations and even countries.

Credit ratings are not assigned by the four credit bureaus of India but by what are known as the credit rating agencies. There are more credit rating agencies in India than credit information companies. Some popular ones are Credit Rating Information Services of India Limited (CRISIL), CREDIT Analysis and Research Limited (CARE), Investment Information and Credit Rating Agency of India (ICRA), Brickwork Rating, SMREA, India Rating and Research Pvt. Ltd and Infomerics Valuation and Rating Pvt. Ltd.

While the rating scale used by most of the credit rating agencies can differ, the credit ratings assigned to corporations, businesses, etc. are always in the form of letters and range from AAA to C and D. Entities that are seen to have the brightest future in economic terms get a AAA rating whereas those which are seen as the most risky from investment point of view receive poor grades such as C or even a D and investors usually shy away from investing in such businesses because the rating suggests a high risk of things like bankruptcy which would mean huge losses for them. On the S&P0 credit rating scale, grades falling between BBB and AAA are categorised as investment-grade, whereas those below them are seen as non-investment grade.

To assign ratings to various entities the credit rating agencies look at things like the entity's history in terms of repaying its debts, how timely they repay their dues, if they have ever defaulted on payments or not, etc. Their cash flow levels and debt levels are also judged.

Companies with poor credit ratings have trouble finding good investors and have to pay very high interest rates to compensate for the risk involved.

Read More:: CIBIL Score Role in Loan Application Process

Key Differences Between Credit Ratings and Credit Scores

Now that you know everything about both 'credit rating' as well as 'credit score', let us go over the key differences between these things:

1. Credit scores are assigned to individuals, whereas credit ratings are assigned to companies, businesses and even countries.

2. Credit scores are calculated by credit information companies or bureaus. Credit ratings, on the other hand, are assigned by credit rating agencies. There are only four credit information companies in India, but there are many credit rating agencies.

3. Credit scores are numerical evaluations of a person's creditworthiness, and credit ratings are alphabetical grades given to corporations, countries, businesses, etc.

4. Credit scores are used to decide an individual's eligibility for things like loans and credit cards. They are also used to assess the amount of risk involved for investors while investing in a particular entity. Credit ratings basically predict how financially stable and successful the entity will be in the future or whether there is a high risk of bankruptcy.

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How to Improve Credit Rating and Credit Score?

By now, it should be evident to you how important credit scores are in the financial lives of individuals and how essential credit ratings are for the economic well-being of corporations and governments. This is why efforts must be made to have a high credit score and a top-notch credit rating.

You only need to adopt good financial habits to improve both things. The biggest thing that individuals and companies need to do is start repaying all their dues on time regularly. In the case of both credit score as well as credit rating, the history of repayment functions as an important factor during the calculation. In short, you need to establish yourself as financially stable in order for lenders and investors to give you money. You need to be seen as low-risk so that you can be trusted with repayment of the money you receive from banks, and investors must be assured of not meeting losses by investing in you.

Credit scores can also be improved by doing some other things such as making as little credit enquiries (known as hard enquiries) as possible, keeping your credit utilisation ratio low, getting more secured than unsecured credit, etc. In case you have loan accounts that have been written off, get rid of them by repaying them and avoid loan settlements at all costs.

Read More:: Is 720 a Good CIBIL Score?

Conclusion

Both credit score and credit rating are terms used to assess creditworthiness. The difference is that while the former is used by lenders like banks, credit card providers, NBFCs, etc. to see how well an individual has handled credit in the past, credit rating is used by investors to see the financial stability and well-being of corporations and other entities before making big investments. Both these terms are basically risk-assessing tools.

While credit scores are calculated by four credit information companies or credit bureaus in India, credit ratings are assigned by credit rating agencies. Credit scores are numerical indicators of creditworthiness, ranging between 300 and 900. Credit ratings are given in the form of letters or grades such as AAA, BBB, C, D, etc.

Low credit scores and poor credit ratings are seen negatively, whereas higher credit scores and grades, such as AAA or BBB, are seen as markers of great financial health and are extremely beneficial for the individual or entity. Therefore, efforts must always be made to get good credit scores and great credit ratings.

Frequently Asked Questions (FAQs)

1. Do I need a credit rating if I want a car loan?

No, if you want to get a car loan, you do not need a credit rating. What you do need is a credit score. Credit ratings are required not by individuals but by businesses, corporations and governments. The lender will check your credit score, which is a part of your credit report, in order to decide whether your car loan application will be approved or rejected.

2. Is AAA credit rating considered good?

Yes, AAA credit is considered a good credit rating. A company with such a grade is seen as very healthy financially and is considered to have a bright and successful future. This is why investors prefer investing in such corporations: They feel safeguarded against any possible losses and assured of making good profits.

3. Where can I get a credit score from?

You can get your credit score by checking it on the official website of any of the four Indian credit bureaus. You can also visit your bank's website or mobile app, NBFC, credit card provider, etc. FinTech platforms of the likes of Paytm, Bankbazaar, Paisabazzar, and Cred also let people check their credit scores for free on their online platforms.

4. Is my CIBIL score and credit score the same?

Yes, your CIBIL score is nothing other than your credit score. TransUnion CIBIL is India's oldest, most well-known, and highly trusted credit information company. It uses data collected from various sources to create everyone's credit scores, which is why the credit score is also commonly referred to as your CIBIL score.

5. What is a good credit score?

There is no particular score that is considered good by all banks and financial institutions. However, most of them consider score above 700 as good and satisfactory to approve loan and credit card applications.

6. What is a credit report?

A credit report is a detailed assessment of a person's use of total available credit in the last seven years. It includes every piece of information related to his credit handling. The credit report is like a financial report card and decides if you have been financially responsible or irresponsible. Based on your credit report and the credit score mentioned on it, prospective lenders judge your creditworthiness and approve or reject your credit applications.

7. Can I ask my bank for my credit score?

Yes, you can ask your bank for your credit report. In fact, you can visit the official website or mobile app of your bank to check your credit score yourself. Most banks now offer their customers the facility to check their credit score on their online platforms without any extra charges being levied on them.