What is credit score? What does it say about you?

6 MinsAug 2, 2021

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Hemant has recently started working and is living away from home with friends. He wants to buy a home theatre system and is looking for a good deal. He realizes that he may have to take a personal loan, because the brand he likes is an expensive one, and he does not want to compromise on quality. While doing his research, he came across advertisements offering to provide his credit score for free. Hemant wanted to know more and had a chat with his flat mate Rishabh, who works in the finance sector. Let’s listen in to their conversation to understand the concept of credit score and the factors that affect it:

Hemant: What is this credit score business that I keep seeing ads for?
Rishabh: To understand the concept of a credit score, you first need to know how banks lend money to ordinary people. The most important factor they will consider is whether you are a reasonable credit risk. This means that the bank needs to believe that if it lends you money, you will have the ability and inclination to repay it. How would a bank know that?

Hemant: They could look at proof of my income, say, salary slips and my bank account details.
Rishabh: Sure, and they definitely do that. In addition, they look at your credit history that is encapsulated in your credit score. It tells them whether you have borrowed money in the past and have repaid it in time.
Think of your credit score like your Grade Point Average (GPA) in our MBA course. If you remember, our GPA was determined by how we did in all our examinations, across the entire MBA programme and not just the last semester. Similarly, your credit score is defined by your repayment history across all your loans – credit cards, auto loans, Personal Loans and home loans. If you default on any of these, it will adversely affect your credit score.

Hemant: But who fixes these credit scores?
Rishabh: There are specialized companies called Credit Bureaus like CIBIL, Experian, Equifax and others. Banks share the repayment track record of all their retail customers with these Credit Bureaus. This includes repayment information on all kinds of loans-such as personal loan, auto loan, home loan, etc, as well as credit cards. The Credit Bureaus aggregate information from all banks and financial institutions and determine your credit score. The credit scores typically range between 300 and 900, with 900 being the highest. Anything above 750 is considered a good credit score.

[Also Read: How to check your Credit Score]

Hemant: And why is a credit score so important?
Rishabh: The credit score determines whether a bank will give you a loan or not and what interest it is likely to charge. A good credit score will improve the chances of you getting a loan on attractive terms.

Hemant: This means I need to borrow and repay to have a credit score. What about someone like me who has never taken a loan?
Rishabh: The point you make is valid. To have a credit score, you need to have borrowed from a bank. But then you can hardly blame the system. If you have never borrowed, there is no data about you, and to the bank, you are an unknown entity.
Banks understand that someone like you who has started his career recently may not have borrowed in the past and hence may not have a credit score. So, they will consider factors like a job in a reputed company and a decent salary before taking their lending decision.

Hemant: But why should I get into this whole credit score tangle? I could ask my dad to lend me the money.
Rishabh: Sure, you could, and he wouldn't mind giving you the money. But think long term. Say, three years from now you want to buy a bike. Or a flat ten years from now. Would your dad be able to lend you that money? You would have to approach a bank for a loan. At that time, without credit history or credit score, you may find it challenging to get a loan, and if some bank does offer it to you, the conditions could be stringent, say, higher interest rate or bigger down payment.

Hemant: You make a good point. But how do I build a good credit score?
Rishabh: You need to build a good credit score over time. Taking a small-ticket personal loan or using credit cards and paying the bills on time helps build a good credit score that can come in handy when you want a larger loan.
For example, I have two credit cards. Though my limit on each of the cards is Rs. 60,000, I never use more than 50% of my credit limit. I also pay my bills in full and on time. This way, I am indicating to the bank that I am a good credit risk. A couple of years later, I plan to buy a car, and this will help in getting that loan on better terms. Maybe, 7-8 years later, I will think of buying a flat. If I can maintain my credit profile, I shouldn't have any problems getting a housing loan of the amount I am likely to need.

Axis Bank has a range of credit products ranging from credit cards, personal loans, car loans and home loans tailored to meet its customers’ requirements. To know more, click here.

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