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How is Credit Score Calculated?

  • July 26, 2021
  • 3 minutes read

What is credit score? 

Credit score measures credit-worthiness of an individual in numerical terms. It takes into consideration a person’s behaviour with credit in the past. Ever payment made on time adds to the score while every missed payment or loan extension reduces the credit score. 

What is an ideal credit score? 

Credit score falls between 300 – 900 points. Credit lenders consider a credit score of 750 and above as an ideal score for availing credit. The higher a person’s credit score is, the easier it is for him/her to avail a loan at low interest rates. 

How is credit score calculated? 

CIBIL score is calculated based on several factors. Each of them is listed and explained below. 

History of repayment 

History of repaying debts is the most important factor in calculating credit score. When an individual borrows a sum of money as a loan, his/her repayment of EMIs in full and on time shows his/her responsibility towards the debt taken. Missing an EMI payment or delaying it repeatedly shows the borrower in a bad light. Repaying dues on time increases the credit score of an individual.  

Repaying loans in full and on time contributes to 15% increase in CIBIL score.  

Utilization of credit 

If an individual regularly borrows from banks or NBFCs, it shows that the borrower relies on credit. It indicates dependency on credit and high risk towards defaulting a loan. Hence, one should borrow only when absolutely required. 

Too many loan enquiries from banks 

When one wants to avail loan from a bank, people tend to enquire from several banks in order to find out which banks offers them the best deal. By best deal, we mean, low rate of interest and higher loan amounts. Multiple banks making hard inquiries on a person’s CIBIL Score has a negative impact on the score. 

Wondering how that happens? 

When an individual approaches a bank with a loan application, banks check the credit score of the individual to determine his/her eligibility for the loan. Every time banks check the credit score of an individual, it keeps reducing by a few points. This is called a hard enquiry.  

An easier way to get the information you want without making a hard enquiry is to make a soft enquiry. Soft enquiry is to request the bank official to not pull-out credit score from TransUnion CIBIL and provide the approximate loan amount one is eligible for.  

You can also use our Home Loan eligibility calculator to determine the maximum loan amount for which you are eligible. Enter your gross monthly income, tenure you want to avail the loan for, interest rate as specified in the loan plan you have opted for, whether you are paying EMI for any other loan, etc. 

Total number of loans applied for and availed 

When one submits loan applications to multiple banks to determine one’s loan eligibility, it lowers the score further. The reason being, The Credit Bureau keeps a track of all the loan applications submitted to the lenders. When you make loan enquiries from multiple banks, it is understandable that you avail loan from only one bank after finalizing the plan you want to opt for. This means that the rest of the banks will reject your loan application. These multiple loan application rejections also negatively reflect on your credit score and lowers your credit score further.  

Credit bureau states that a bank rejects a loan application when they deem that the individual is not eligible to receive a sanctioned loan. This lowers the CIBIL score as the credit worthiness goes low.  

Also, when an individual avails multiple loans, it indicates credit-hungry behavior. Lending institutions do not appreciate this as the rate of loan defaulters is higher in individuals who have multiple loans running.     

Type of credit availed – Secured and Unsecured 

What is secured loan? 

When you apply for a loan using a collateral with the lender, it is termed as secured loan. This is because the lender has possession of the article you’ve signed off as collateral. Lender has all rights to sell the article of monetary value in order to recover his loan in case it is not paid on time. Property, gold and such other tangible assets are used as collateral. 

What is unsecured loan? 

Loan issued without a collateral is termed as unsecured loan. CIBIL score and other factors are taken into consideration while determining the applicant’s eligibility for the loan. Unsecured loans are given at a higher interest rate when compared to secured loan because the risk quotient is higher. 

Availing only one type of loan – either secured or unsecured, does not contribute to the increase of CIBIL score. The type of credit availed contributes to 10% of the CIBIL score. In order to increase your score by 10%, get a mix of secured and unsecured loans. Not availing any credit at all does not help in maintaining the score. So, it is better to have a healthy mix.  

Credit utilization ratio 

It is calculated by the amount of credit used to the amount of money available as credit to an individual. Outstanding balance divided by total credit limit determines the ratio. Financial institutions look at loan applicants with a credit utilization ratio below 30%. This also increases the CIBIL score of an individual.  

Now that you know how credit score is calculated, what are you waiting for? 

Start working towards building a high credit score to be able to borrow later on in life. If you have any questions regarding CIBIL score or loans, do address it in the comments section below. 

Written by: Marketing Fincity

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