The times, they are a-changin'
~ Bob Dylan
Bob Dylan had it right. Things are very different today than they were a generation ago. Today, our generation spends a lot more than our parents or grandparents ever spent. Mainly because life itself is more expensive. We have higher incomes, but more desires. We want to own homes faster, take more exotic vacations, avail the plethora of lifestyle choices and basically achieve all our life goals and dreams… all of this leads to significant cash outflow per month and per year.
This is often not funded with available cash in the bank. Retail credit offtake has increased exponentially to fund these purchases. How does the Government and the RBI keep track of all the home loans, personal loans, car loans and other debt that is causing so much money to back so many assets? At an individual level how do banks decide how much of a loan to give to a particular borrower? How do they understand and quantify the risk you pose?
Through credit information bureaus.
(To find out how a loan can help you achieve your dreams, read our article How to Build Wealth with a Loan.)
What is a credit information bureau?
A credit information bureau is nothing but an organization that collects and collates data on borrowers – both commercial and consumer. It has banks, financial institutions, NBFCs, housing finance companies, state finance corporations and credit card companies as its customers and shares credit information with them on the basis of reciprocity, through Credit Information Reports or CIRs.
Due to the increasing credit offtake in our economy, the RBI and the Indian Government got together in 1999 to create a Working Group to assess the need and operational procedure in setting up a credit information bureau. In January 2000 CIBIL was set up, promoted by SBI, HDFC, Dun & Bradstreet and TransUnion. CIBIL is the Credit Information Bureau (India) Limited and it was the first credit information bureau in our country.
How does a credit information bureau function?
For banks or lending institutions to get a thorough picture of the credit-worthiness of a particular loan applicant, they need to have access to this applicant’s full borrowing and repaying history. As an individual, you may have taken a car loan from Lender A, a personal loan from Lender B, have a credit card from Lender C and be applying for a home loan from Lender D. Before Lender D gives you a home loan, it must check multiple things, such as your salary, your age, your past EMI repayment history, regardless of whether you have defaulted or you have repaid earlier than required, and so on. It gets this information from a Credit Information Report, issued by a CIB, in this case CIBIL.
What is a Credit Information Report (CIR)?
Your Credit Information Report is nothing but a factual statement of your credit payment history. This information is put together from different credit givers. It helps future credit givers make an informed decision on how much credit to offer you and on what terms. A major factor in these decisions is your credit score – a score assigned to you by credit information bureaus such as CIBIL.
How do you check your credit score?
If you want to know your CIBIL TransUnion Score, you can visit their website Form Download page, fill the form, make the payment of Rs. 450 and you will receive your CIBIL TransUnion Report online.
Why is it necessary to have a good credit score?
Your credit score plays a critical part in the loan granting process. Based on your credit score, a bank will decide how much interest to charge you on the loan you want to take. These reports contain your basic information such as name, date of birth, address, and past payment history, overdue amounts if any, records of all the credit you have taken in the past, number of inquiries made on you by different lenders. All of this information is useful. For example, if there is a high number of inquiries made on you by different lenders, it shows that you have approached multiple lenders for loans, whether or not those loans have been taken or not. This is not a good thing.
It is also important to note that not all lenders have the same definition for a ‘good’ credit score. For example, a CIBIL score of 670 may be an adequate credit score for certain loan providers, but many will reject a loan applicant with this score.
80% of all new loans are sanctioned at credit scores above 750. The higher you score, the more favourably lenders will view your application.
How can you use your credit score to your advantage?
Credit bureaus act as weeding mechanisms. They protect lenders from bad borrowers. But you can also use your report to your advantage. If your track record is unimpeachable, you can bargain for a lower interest rate from your bank. It can also work to help your bank give you a loan quicker, and possibly waive certain processing fees too. The bank this way does not have to spend time on researching your background and can give you a loan under the assumption that you are a safe borrower.
What factors on the Credit Report are most critical to your loan application being approved?
There are 4 key factors that banks and lenders will look at. These are:
- Your Payment History
Taking the CIBIL report as an example, your payment history will appear in the Accounts section. This details your Days Past Due (DPD) and the month and year of payment. DPD indicates how many days past the due date you have made that particular payment, hence Days Past Due. If the number is 0, it is fine. If your payment is even a day or two late, it counts as negative. The later you pay, the more negative this is.
In reverse chronological order, the last 3 years i.e. 36 months of payment data is listed here.
If you own multiple credit cards, and there are some you don’t use but still own, you must be sure to know each one’s Terms and Conditions. Some cards have no fees while others charge a fee from the second year onwards. If this is the case and you don’t pay the fees probably because you are unaware of them, then the fees and interest keep accruing, and this reflects on your CIR.
- Your Current Balances
This also appears in the Accounts section of the CIBIL report. It shows the how much outstanding you have on any loans you have taken. So if you took a car loan and have paid off most of it and only have say Rs. 50,000 left, then Rs. 50,000 will reflect here, for your car loan. It basically shows how much debt you still owe.
The lower this figure, the better. Lenders will not feel comfortable lending to someone who has a high level of current loans outstanding already, while applying for a new one.
- New Credit Facilities
If you have recently availed loans i.e. new credit facilities, then your ability to repay a new loan will be low. This is negative for your application.
- Number of New Enquiries
If you have recently applied for a few loans, this makes you look ‘credit hungry’. It makes it look like you are in urgent need of money. This also is negative for your application.
What steps can you take to improve your credit history?
- The first thing you can do is to always pay your bills on time.
- Keep your balances low and control your credit usage. For example if you have a credit card with a limit of Rs. 5 lakhs, try to not use Rs. 4.90 lakhs credit. High credit usage can be viewed negatively by a loan provider.
- Avoid Credit Hungriness. If you have made multiple new loan applications, it reflects badly.
- Carefully monitor any co-signed and joints account you may have. If any payments are missed by your joint holder or co-signee, you are held equally liable and this can affect your credit application when you make it.
So remember, check your credit score, improve your credit behaviour and benefit from the next loan you take. For expert advice on how to manage your cash flows and achieve your dream home, feel free to Call Us to build your financial plan.