Cracking Credit Scores, What is it and what It means

Are you ready to embark on a journey to financial wisdom? Welcome to ThriftyOwl.Club, where we explore financial mental models and hacks, helping you enhance your financial acumen one hoot at a time! Today, let us decode credit scores and understand how it can transform your financial future.

Jay had no financial troubles until he desired to study abroad and needed to apply for an educational loan. That’s when he realised that along with his academic scores and report cards, he needed another scorecard as well: credit scores. A credit score is a three-digit number that provides a snapshot of your creditworthiness and overall financial well-being. Let us decode how Jay created a credible credit history and got himself the loan for a lower interest rate.

Understanding Credit Score

A credit score is a numerical score ranging between 300 and 900. In India, credit score is often synonymously used with “CIBIL score”. CIBIL ( Credit Information Bureau India Limited), is an Indian credit rating bureau that has access to your credit history, the number of accounts, total levels of debt, repayment history, and other factors.

Credit scores play a key role in a lender’s decision to offer you credit. The higher your credit score. the more likely you are to get a loan approval at better interest rates. A credit score of 700 is generally considered good enough for you to qualify for a loan, especially at lower interest rates. Here are the general ranges for how credit scores are categorized.

• Excellent: 800–850

• Very Good: 740–799

• Good: 670–739

• Fair: 580–669

• Poor: 300–579

But how does one like Jay, who has just embarked on his financial journey create a history of finances? Though zero history is not considered bad, some lenders hesitate to start with zero information. hence, let us find out with Jay how to get off to a good start on your credit profile.

1. Apply For A Secured Credit Card

   Getting a credit card against your fixed deposit is one of the easiest and earliest ways to start building your credit history. These kinds of credit cards are called secured credit cards. The amount in your fixed deposit account is directly linked to the total credit limit on your credit card. use this credit card to make payments and transactions while also ensuring that you pay them back regularly and at any point not crossing the limit.

2. Get Your Name in an Add-on Card

   This is yet another easier way to get your credit score high. You can piggyback on your family or friend’s credit card and get an add-on card. Using this card for your monthly expenses can build your credit. Again being within the limits and maintaining its responsibility.

   The key here is to check whether the credit card owner has a good credit score, a bad history of the card owner might affect you too.

3. Apply For a Credit Builder Loan

   Another simple way is to get a small loan and start repaying it. In Jay’s case, he chose a small personal loan of a couple of lakhs and started repaying it diligently. This will set an example of how responsible you are and get your credit scores higher.

4. Pay Later

   Another simple hassle-free option is to opt for the pay-later option in e-commerce sites. This is a popular trend amongst consumers today and most millennial options.

Jay found a way to create a credit history and also improve his credit score, but he didn’t stop at that he delved deeper to learn more about the factors that affect the CIBIL score and their weightage percentages in the score.

Factors Affecting Credit Score

The weightage percentages of credit score factors can vary between different scoring models used by credit bureaus. However, as a general guideline:

1. Payment History: Timely payments, late payments, bankruptcies and no defaults in your credit bills and EMIs are assessed as payment history. Approximately 35% of your credit score is based on your payment history, making it the most significant factor.

2. Credit Utilization Ratio: This ratio compares the total credit you've used to the total credit available to you. If your credit utilization exceeds 30%, it can negatively affect your credit score. This accounts for about 30% of your credit score. Maintaining a ratio below 30% is crucial for a positive impact.

3. Total Number of Accounts: Having multiple accounts, mortgages, auto loans, personal loans and credit cards has a positive impact. The variety of credit accounts you have contributes around 15% to your credit score.

4. Age of Credit: The length of your credit history constitutes about 20% of your credit score. Older accounts have a positive influence.

Now let us understand how a good CIBIL score can help you in life.

Better CIBIL Score Better Savings

Though the CIBIL score is not the only parameter that decides your creditworthiness, it carries a big weightage in your loan or credit card approval. the following are some of the key benefits associated with a high credit score:

1. Enhanced Approval Odds: Having a high credit score showcases your responsible credit habits and minimal default risk, significantly increasing your likelihood of getting approved for loans or credit cards.

2. Reduced Interest Rates: Lenders tend to offer lower interest rates on credit products such as personal loans, home loans, or credit cards to individuals with high credit scores, making borrowing more cost-effective.

3. Access to Pre-approved Offers: A strong credit score opens doors to pre-approved loan and credit card offers, expediting the borrowing process with minimal paperwork and swift approvals.

4. Exclusive Access to Premium Credit Cards: Lenders prioritize applicants with high credit scores, granting them access to premium credit cards laden with enhanced rewards, cashback, and premium services.

5. Higher Loan Limits/Credit Card Cap: A robust credit score elevates your chances of securing loans and credit cards with higher limits, reflecting your reliable credit behaviour and reducing the risk for lenders.

6. Possibility of Extended Loan Tenures: A good credit score may enable you to obtain loans with extended repayment periods, resulting in smaller monthly instalments and alleviating your monthly financial burden effectively.

At the end of the year, Jay applied for his educational loan again and this time with his newfound healthy credit habits he got that loan approval at an interest rate, 1.5% lower. He had asked for a loan of 18 lakhs @ 8% per annum for 6 years and this time got it @ 6.5 per annum for 6 years. He saved around 93000 approximately. 0

Well, Jay was fortunate to know all of this in his first loan application, A lot of us learn these things only after splurging on our new credit cards in the pretext of “Carpe Diem”. If you are one of this kind, well this damage is reversible and we have brought you a few tips to improve your credit score.

Habits That Improve Your Credit Score

Get Organised

Start paying your dues on time. Be diligent and do not miss your EMIs and credit card payments. If you need to set reminders. payment delays cost you penalties and also your credit score. Try automating bill payments.

Small Credit Strategies

Do not take too much credit simultaneously. Opting for multiple loans at the same time will bring down your credit score crashing. If you need loans take loans one by one and repay them without any default. This will boost your CIBIL score.

Credit Mix

Maintain a healthy credit mix; a combination of secured loans( such as home loans, and auto loans) and unsecured loans(such as personal loans and credit cards) of long and short tenors held a good credit score.

Borrow Wisely

Apply for new credit only when necessary, and ensure you can easily pay it back. Too much debt can harm your credit score, so be mindful of your borrowing habits.

Watch Your Shared Accounts

Be cautious about joint accounts or co-signing loans. If the other person misses payments, it can impact your ability to get credit. Avoid becoming a joint account holder to protect your credit.

Check Your Credit Regularly

Keep an eye on your credit score and report. Mistakes can happen, and incorrect information might hurt your score. If you spot errors, fix them promptly to maintain a healthy credit profile.

Build Your Credit Slowly

Debt isn't always bad if managed wisely. Opt for longer loan terms for lower EMIs, and don't max out your credit limits. The key is to have available credit but use it responsibly. Over time, this strategy helps you build a strong credit score for better loan opportunities.

Jay has come to understand that debt and credit are not in itself evil- It’s all in the balance. U too understand it build and improve your credit score.