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Credit score or credit history of an applicant plays a vital role in determining loan to the applicant. In today’s financial market credit score determines the rate of interest at which loan will be provided to the applicant. Credit history also determine whether loan will be given to the applicant or not. Lower credit score means higher risk for the loan being provided, so the rate of interest will be higher. In simple words if the credit score is low then rate of interest will be higher and if credit score is high then the rate of interest for the loan will be lower. 

So, credit history and credit score are the two crucial factors which determine whether loan will be provided to the applicant or not and if its being provided then what will be the rate of interest.

In India there are three credit information providing companies (i) Transunion CIBIL (ii) CRIF High mark (iii) Experian. Credit score of an individual from different credit information companies varies as there are various methods or models on the basis of which credit score of an individual is calculated by each company, and one of these models is FICO method. FICO method was devised by Fair Issac Corporation and in this method different weightage is given to different credit related financial activities of an individual. Under FICO method:

  • No. of enquiries is given weightage of 10%: If any enquiry for a loan is made quite frequently these enquiries lead to erosion of score and then credit score decreases further. 
  • Having different kinds of loans is given weightage of 10% : If an individual has different kinds of credit products then it increases the credit score i.e. he has availed more than one kind of credit products such as credit card facility, personal loan and home loan etc. The credit portfolio of individual includes both secured and unsecured credit facility then his/her credit score enhances.
  • Amount of debt availed out of the existing credit limit is given weightage of 30%: If an individual has availed 30%-40% of his credit limit i.e. the limit of amount up to which an individual can be provided loan depending upon his/her financial capability such as income minus existing credit.
  • Payment history gets weightage of 35%: Timely payment of credit card dues and EMIs of loan amount, creates positive impact. If an individual has long credit history, then it also creates a positive credit history. So, these two factors i.e. timely payment and long credit history lead to increase in credit score of the individual. In some of the cases an individual become guarantor of a loan, then the default in payment by the applicant towards EMI of this loan is considered as default by the guarantor too. So being guarantor of a loan can impact credit score both positively and negatively.

     Ways to improve credit score:

    There are various steps and measures with the help of which an individual can enhance his/her credit history as well as credit score. 

  • Purchase of credit report: Purchase credit report from any credit information providing company at least one year prior to availing any credit facility to know the credit score and credit history. Its very important also to purchase credit report and not get it from any banker at regular intervals such after six months to know your credit history.
  • Less enquiries for credit facilities: When an individual applies for some credit facility at various financial institutions or gives to a mortgage agent who applies the application form at various financial institution, that leads to creation of numerous enquiries in the name of the individual. These enquiries are reported by financial institutions to the credit report company and credit company decreases the credit score of that individual for each enquiry. 
  • Availing both secured and unsecured loan: In the credit portfolio of an individual there should be a good mix of both secured and unsecured loan. Secured loan is considered to be a product which fetches more positive points in comparison to unsecured loan products.
  • Lower % of credit out of existing credit limit: The credit availed by an individual should not exceed more than 30-40% of existing credit limit of an individual. Depending upon income and age of an individual, credit limit of the individual is fixed. Once the credit limit has been created, the total loan availed or to be availed, clubbed together should not exceed 40% of the limit.
  • Payment of EMIs and dues of credit card to be made on time: Highest value is given to timely payment of EMI and bill amount due on credit card. Thing to consider is that even a loan in which an individual is guarantor impacts the credit score of the individual, so its EMI payment should be checked frequently by the guarantor of the loan. In case certain dispute arises regarding credit card bill payment, due to annual fees charge, billing amount etc., the dispute should be settled amicably as soon as possible. Prolonging of such dispute in order to avail better bargain, creates more harm in the form of negative credit score than the financial gain from the bargain.
  • Shifting of higher interest product to lower interest rate product: Higher rate of interest has two negative implications; one it leads to serving of more interest on the loan amount and second is higher EMI amount.  Higher EMI leads to higher % of credit out of existing credit limit of an individual, this negatively impacts credit score. So, credit facility at higher interest rate should be shifted to loan product having lower interest rate.
  • Correction of information on the credit report: Mistakes in details such as residential address and phone number etc. leads to transfer of credit history of another individual. This may lead to decrease in credit score as the other individual might have negative credit history. Sometimes the lending bank or financial institution gives wrong information about credit history or activity of an individual, under such scenario the individual must raise dispute primarily with the lending institution and secondarily report to the credit information providing company. Escalation of dispute in such cases is essential as this acts as proof that the individual’s credit history has suffered due to mistake of others.

These measures are essential to keep credit report of individual or company healthy.

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