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An individual’s credit score determines their creditworthiness. It is a vital factor that financial institutions use to assess a loan/credit application and decide on the loan amount/credit limit, interest rate, and other terms and conditions. A decent credit score portrays the applicant as a trustworthy and responsible borrower. It is one of the key requirements for applicants seeking an instant loan. While conventional lending institutions require a credit score of more than 750, new-age lending institutions like Clix Capital require 630 as the minimum credit score for a personal loan.
By consolidating an individual’s past repayment behaviour and credit history, the credit score gives a comprehensive view to prospective lending institutions and NBFCs. A higher score ensures creditworthiness and vice versa. To understand it better, learning how the credit score is calculated is essential. Here’s how it works.
Factors Affecting the Credit Score
Several factors go into calculating the credit score. Therefore, an individual should focus on them while trying to improve the score. Here are the most common parameters that affect the credit score:
- Payment History: Defaulting on EMIs and making late payments hurts the score significantly.
- Credit Mix: A balanced mix of secured and unsecured loans will likely have a positive impact.
- Loan Enquiries: Multiple loan enquiries within a short period will hurt the score as it projects the applicant as a credit-hungry, high-risk borrower in the future.
- Credit Utilisation Ratio: A high credit utilisation ratio indicates an increasing debt burden with time and negatively impacts the score.
The 3-digit credit score ranges from 300 to 900. The closer the score is to 90 0, the higher the chances of loan approval. Typically, 630 is the ideal credit score for a personal loan.
How is Credit Score Calculated?
Credit bureaus like Experian and CIBIL calculate credit scores based on various credit-related factors. Here is how they do it.
Repayment History: How an individual has repaid loan EMIs and credit card bills in the past makes up a significant percentage of the credit score. That is why missing EMIs and defaulting on repayments severely diminish the overall rating. Lending institutions require a minimum credit score for personal loan to ensure consistent repayment by the applicants.
Credit Utilisation and Existing Debt: The existing debt makes up around 30% of the credit score, and it also reflected in the credit report. The credit bureaus calculate the score based on the credit amount available and what percentage of it you consume. Taking too much credit compared to the income or using the most available monthly credit increases the credit utilization ratio and negatively affects the credit score.
Types of Credit Availed: The kind of credit lines availed contributes up to 10% of the credit score. Handling only one kind of credit in the portfolio does no good in improving it. Avoiding taking one type of credit altogether is not good either. Having a balance of different credit types creates a positive impression and contributes to the credit score. That means taking secured, unsecured, short-term, and long-term loans for various purposes.
Duration of Credit: The repayment term contributes significantly to the credit score. The credit bureau considers how long you have been availing credit and whether you have consistently made timely payments. Building credit takes time. Those handling credit wisely for a long tenure are more likely to have a higher credit score than new debtors.
Number of Credit Enquiries: Every credit or loan application is considered a hard enquiry and appears on the credit report. Too many loan enquiries within a short period indicate a credit hunger and reduce the credit score. Besides, each loan rejection also marks negatively on the credit score as it means that the lending institution did not find the applicant financially capable of handling credit. That is why checking credit scores and meeting the eligibility criteria is crucial to ensure approval.
Checking the credit score regularly and ensuring it is up to the mark helps take the required steps in time and maintain the minimum credit score for personal loans. Besides, it also brings any errors to attention. Reporting them and requesting corrections will instantly boost the credit score. Visit the website of a reputable lending institution like Clix Capital to check your credit score for free.