What is credit worthiness and how it helps in getting loans
You may have often noticed that you receive calls from bank representatives suggesting an attractive personal loan or credit card offers when you do not actually need them. Banks often go after people with an attractive credit record.
Banks conduct background checks before lending you the money. Some people even get their loan applications rejected. The reason is almost always related to their credit worthiness.
What is credit worthiness?
In simple terms, credit worthiness deals with the likelihood that a person will fail to pay back loans. The more credit worthy you are, the higher is the chance that you will pay back your loans.
Credit worthiness is measured by the credit score. This is offered by the Credit Information Bureau of India Ltd (CIBIL). This score is very important when you apply for a bank loan. The lower your score, lower are your chances of getting money as a loan. It is one of the most crucial factors in determining whether your loan application should get accepted or rejected.
This credit score depends on your past actions. If you have a lot of dues pending or a history of late payments, your CIBIL score could be lower.
You can obtain your CIBIL score by logging on to the website of the bureau.
Why do banks check credit scores?
Ever wondered how banks make money? It is simple; they first accumulate money through deposits and then lend it to customers as loans at a high interest rate. Then, they pay back depositors an interest, which is always lower than loan interest rates. The banks pocket the extra money left as profits.
This is why loans are extremely important for banks-it is their primary source of income. Sometimes, however, lending money may backfire. The borrowers may not have the finances to pay back the money. This results in a loss.
As a result, banks are extremely cautious about who they lend to. It is riskier to lend to a person who has had a poor record of managing their finances. History may repeat itself, and the person may fail to pay back the loan. On the other hand, a good credit score reflects that you are more likely to pay back the loan on time. This means, the bank will not face a loss. As a result, they are more willing to lend to people with good credit scores.
What factors affect your credit score?
Firstly, it depends on your previous debts. Did you borrow too much money? Do you borrow regularly? Are you already juggling too many debts? Have you paid back the money after great delays? Have you failed to pay back any money? If yes, then you are likely to have a lower credit score. The idea is that if you already have enough money to pay back, then there is lower chance of you paying back another loan.
Even loan guaranteeing affects your credit score. As a loan guarantor, you have to pay back a loan if the actual borrower fails to do so. This means you are exposed to the risk of a loan payback. Anything that eats into your money could lower your credit score. So, if you have guaranteed loans, especially for high amounts, you could end up with a lower credit score. This also lowers the chance that a bank would lend you money.
Here’s a quick check-list of the factors that affect your credit score:
- A history of multiple loan and credit card applications shows ‘credit hungry’ behaviour. This can, thus, lead to a lower credit score.
- Banks and lenders are wary of those who pay late. Consistent delayed payments shows irresponsible behaviour. Also, it could mean regular cash crunches. This is negative for the credit score.
- Over-usage of the credit card; regularly crossing the credit limit set, or even utilising the entire credit limit can lead to a lower credit score.
- Some loans like personal and credit card loans are considered unsecure loans. These affect your credit score more negatively than secured borrowing like home and auto loans.
- Alternatively, buying a credit card and not using it at all; or only using a credit card without ever applying for a loan, could also seem suspicious. This could also affect your credit score. It is best to have a decent mix of both loans and credit cards.
- Track your CIBIL score regularly. It is quite possible for the credit report to have incorrect or faulty information. Unless you monitor this, and point out the mistakes, the report will not be corrected. You may end up with a lower credit score unnecessarily.