Having a sound knowledge of the credit market is very important to achieving your financial goals. Very few people are aware of the consequences of missing just one payment on their next EMI and how it could become a big issue. The government sets up many rules and regulations on loans, debts, and other financial aid available in the market, but there is only one thread that binds them all for every individual, and that is the Credit Score.

What is a credit score and why is it important?

A Credit Score determines a person's ability to repay a loan in the future or even get a decent amount at a reasonable rate. In earlier days, there were fewer financial institutions offering a loan, and hence, only fewer checks were made in case someone applied for a loan. In today's time, there are hundreds of financial organisations, such as private/government banks, loan applications, stock trading firms, gold loan providers, etc., which provide loans to all types of customers. Hence, it is important to measure a person's financial health using a common tool, the credit score. There are many people who still are unaware of the benefits and disadvantages of having a good or a bad credit score, and that information can save someone a lot of money in times of need.

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Before understanding the meaning and applications of a credit score, it is important to know why credit score is an essential part of the qualifying factors for any type of loan in India. In our school days, our marks were used to quantify our future prospects of getting our desired stream of courses or a good college admission. In our adult life, our credit score determines our ability to get our desired amount of loan, our preferred tenure for payback, and a chance to get a loan from a legitimate financial institution.

There are a lot of benefits of having a good Credit score for any individual or organisation-

1. Having a good credit score could mean that any renowned financial firm would easily provide you with a loan for your business or personal purposes at an affordable rate of interest. On the other hand, having a bad credit score can directly impact your ability to acquire the desired amount from any organisation.

2. A good credit score is also an indication of making good financial decisions, which could help someone secure their future by easily getting money whenever they want. If you do not make your due payments and have more than a few missed payments, then it can adversely affect your ability to get help in the future.

3. You can actually save a lot of money just by maintaining a good credit score. Whenever a bank provides a loan to a customer, the rate of interest is always dependent on the individual's credit score. The higher the credit score, the lower the interest rate for any loan, so why pay an extra amount when you can get the same amount of loan money with lesser overhead charges?

4. Credit score can also impact your current loans as well. If you already have a loan that you are repaying and in case your credit score gets better, you can also avail the facility of EMI recalculation, where you would become eligible to either decrease the amount of interest on the loan or the tenure for which you have acquired it. Note- This recalculation is only possible in case of a loan taken on a floating rate of interest and not a fixed rate of interest; that is why it is always advised to take a loan on a floating rate in case the amount and the tenure are bigger such as a home loan.

5. A person's eligibility for certain types of loans or credit products increases by a huge margin if he has a good credit score. For example, most government home loan schemes, special types of credit cards, and instant funds applications offer their products to people who have a credit score over and above a certain level, and no one else is eligible for the same. It can be a good way to avail yourself of the benefits of these products and save some money in a passive way.

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How is credit score calculated?

A credit score is a quantitative description of a person's financial well-being. It is used as the main measuring tool by all types of financial institutions to determine a person's eligibility to acquire any type of loan or credit product, such as credit cards, consumer finance, loans against property, etc. The CIBIL score is the main score that is considered by everyone for calculating a person's credit discipline.

Certain factors make up the total credit score of a person, and each plays a crucial role in making the final score-

Repayment History

A person's repayment history is an important indicator of his/her financial stability and whether he/she will be able to repay any loan they take in the future. People usually make the mistake of not making EMI payments on time in the early stages of their careers, and they regret it in the future when they require loans for bigger purchases like a home or a car. This factor contributes to 30% of the overall credit score calculation.

Credit Mix and Duration

Having a good mix of credit products and duration of holding those products is important to showcase your expertise in the matter and your ability to make financially sound decisions for longer. If a person has a home loan, car loan, or loan against property for a longer duration of time and has been making on-time payments for them, this will help him to get his credit score in a good position. The total CIBIL score has a 25% of calculation extracted from the credit mix and the duration of loans of a person.

Credit Utilisation

There are many fraudsters who use credit lines to move money around and try to pay off one debt by taking up another credit from a different organisation and then not making a payment to anyone. In these types of cases, credit scores are reflected poorly if they are not done in the right way, as the credit utilisation of a person increases without any increase in on-time payments. Credit utilisation should be kept to a good medium level at all times. This also constitutes 25% of the overall Credit score.

Number of credit Enquiries

If you try to get more credit from different places in case you are not able to acquire it from one organisation, even that can be an indicator of bad financial decision-making, as more credit enquiries without any fruitful results might lead to a decrease in credit score. This makes up 20% of the credit score.

What is a good credit score, and how do you maintain it?

A credit score of 700-750 and above is considered a good credit score by all financial institutions; it can get you a decent amount of loan at a desired tenure at an affordable interest rate. Suppose a person has a credit score higher than 800 or 850. In that case, that is considered to be the golden goose in the financial world, and they get the best type of deals and the best rate of interest from any lenders; only 2% of the people are able to achieve this score and maintain it accordingly.

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Basic Steps to maintain a good credit score

1. You should make sure to make your EMI payments on time, and in case you cannot pay the full amount of an instalment, you should be proactive in contacting the lender and coming on some type of a payment plan for the same which will still keep your credit score in check and will show up as a timely payment with a longer tenure. In some cases, lenders also provide some settlement in case the person cannot make any future payments, which negatively affects the Credit score.

2. You should only apply for loans or credit cards when you need them; otherwise, failed applications might reflect a bad repo on your credit score and affect your current loans.

3. Always try to make on-time payments for a longer period of time. Sometimes, you may have the money to pay off the whole debt in one go, but it is always advised to make payments over a longer duration on the agreed tenure, which also helps you avoid the pre-closure charges and helps maintain a good credit score.

4. You should never try to pay a debt by taking debt from another bank. If you ever find yourself in such a situation, please contact a financial advisor to help you make a better decision, as this can also impact your financial credibility in the credit score calculation.

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Ways to improve credit score

1. If a person wants to have an increased Credit score, the easiest way to do it is by taking up more loans or credits and making on-time payments for the same. More timely payments will gradually increase your credit score.

2. It is also advised to have a good mix of credit products to show a responsible spending pattern and the ability to take up more loans in the future.

3. If you have just learned about Credit scores and their functioning and discover that yours is low, you must get your CIBIL report from their official website. This will help you determine the reasons behind a decreased credit score and what was missed in the past, which could help you avoid such mistakes in the future.

4. Certain financial companies provide support for increasing credit scores by taking a consulting fee and using a lesser amount of your money in certain types of loans to increase your credit score faster. If you choose such a financial firm, please make sure that you get this done by a legal, government-approved firm only to avoid any fraud.

5. The CIBIL score has all your details, such as name, address, phone number, employment information, monthly salary, and number of bank accounts and credit cards. It is always advisable to keep all this information in sync with your official government documents to make sure that firms do not blacklist your profile for having different information on different cards or bank accounts, as it indicates a fraud pattern.

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Conclusion

Answering the question, what is a credit score? A credit score is an essential weapon in your and your family's financial health. If used correctly, it can be useful for you to make future decisions easily with the help of financial aid. The credit score is not only used for loans or credit cards, but it can also be helpful to your family when you require a good loan in case of an emergency. Hence, always make sure that you check your credit score regularly and try to maintain it well above 750 at all times.

FAQs

1 - What is the time limit for a closed account or a missed payment to be visible on my credit report?

The credit report contains data from the beginning of an adult's credit life until its end, and nothing is removed or can be removed by anyone. However, it usually takes about 5-7 years to counter the bad effects of a black spot on a credit file by making regular, timely payments.

2 - Which are the top Credit Score providers in India?

There are 3-4 major credit score companies in India, which all financial institutions use to measure a person's financial viability: CIBIL Score, Experian, Equifax, and ICRA.

3 - Does my credit score help in reducing my current loan tenure?

Yes, having a good credit score can also help you decrease the tenure or rate of interest on your current loans. The only condition is that the loan should have been on a floating basis rather than a fixed basis.

4 - Does salaried employees have a better credit score than the businessmen?

The credit score uses a holistic approach when calculating viability, and it is not only affected by monthly salary credits. If a salaried employee does not make timely payments, he can have a lesser credit score than a businessman who has a better payment history. It completely depends on all four factors determining a person's credit health, not just their monthly income.

5 - Why is it important to keep a check on my credit score every month?

Data theft is a common practice today. It could lead to someone using your details to take a non-authorised loan, which can impact your credit score without you losing any money but can be equally harmful to you. Hence, it is advised to always keep a monthly report handy for your credit score and flag any discrepancy real-time to the Credit score facilities.