We all need credit. One day or another, we all borrow money in any format or another. So it’s worth knowing what credit score is. But before going to credit scores, first, understand lending and borrowing.
Say I need ₹1,00,000. So I went to the bank to get a loan. Bank itself will not lend me. It will find someone else who will be ready to give that money to me. Say, Mr. X. This Mr x can be one person with ₹100,000 or 100 people having ₹1000 each. Bank in return commits some return in the format of Interest on it say 2%. It will lend that money to me or 6 or 7% and keep that difference for itself as it made the job of meeting Mr x and me. That is the core part of banking.
Now possibility here is what is the risk here to lend that money to me? is there any history of me taking loans and not paying them? Or having short of money when I am supposed to pay? did I have the capacity to repay all the loan taken by me? is there any other loan on me? If yes, what am I doing with it? If possible what are my transactions? what are my financial behavior and transactions telling about me the bank? Here the bank is an intermediary and as I am keeping my account with a bank, it is easy to keep an eye on that. But when we are talking about complex systems like the bond market where trusts came into the picture and, maybe more complex institutions came into the Picture, this information is needed and also hard to get our hands on. What if I am talking about the whole country, state, or an MNC?
Here come credit bureaus. They keep an eye on all this. A credit bureau is an agency that collects and researches individual credit information and sells it to creditors for a fee, so they can make decisions about granting loans. This includes and is not limited to your payment of income tax, credit card bill utility bills any police challan that went unpaid, and maybe your phone bill. This all helps to determine the Debt income ratio, your expense ratios your expense habits, and many other things. Credit bureaus assign credit scores to individuals based on the credit history that they assemble. In way more simple terms, credit bureau does the same work which rating agencies do for nations or companies and institutions. Credit bureaus do not decide whether or not you will get credit. They merely collect and synthesize information regarding your credit risk and give it to lending institutions.
Credit bureaus partner with all types of lending institutions and credit issuers to help them make loan decisions. Their primary purpose is to ensure that creditors have the information they need to make lending decisions. Typical clients for a credit bureau include banks, mortgage lenders, credit card issuers, and other personal financial lending companies. Consumers can also be customers of credit bureaus, and they receive the same service which is information about their credit history. This comes in handy when you want to know your creditworthiness and improve it.
Credit scores range from 300 to 850. 300 means low and not worth giving a loan. 850 means you are worth giving a loan. Some factors which I want to highlight here as they will be important while improving your creditworthiness. Payment history is a large part of your credit profile. 35%. In simple language, if you were trustworthy in past you may be the same in the future. Late payments may not sound big now but they can easily show up on your credit history and can make you less credit-worthy.
How much debt do you have right now? higher the amount, the less possibility bank will think about you. Many times you may think for getting a good credit score, you are supposed to don’t have to score or zero debt is good or not at all borrowed. What is here important is whether you took a loan in past makes your credit history. so not borrowing means not having any history. Bad thing. Having zero credit is worst than having tons of it. So better to keep the right amount of debt that you can service. You need to show banks that you can handle debt without going bankrupt.
Length of credit history. The more regular borrower, the better it is. it shows that for a longer time, you can manage the longer length of debt as you have the cash flow for a longer time. Types of credit and new credit highlight another aspect. Type of loan means a car loan or a home loan or mortgage or anything higher. Whether you are on home equity or what show your creditworthiness. types of credit should be diverse the better. That show you are not dependent on one line of credit and other sources of credit. New credit means how often you took loans. A bank finds you at risk if you are taking a loan twice every month. which will increase the amount of debt.
Now let us come to the second part of the post.
Improving your creditworthiness. How to do that.
Late payments are painful. Some Banks and Finacial institutions and some other companies may fine you for late payment but that’s not all. They can easily disturb your FICO score or CIBIL score or whatever term of your country. A lower score means a Low possibility of getting into debt. Even if you get debt, the rate at which you’ll get will be higher. so no late payment. and in fat credit cards, late payments also cost high.
Regarding credit cards, I remember, I read one article in the Economic Times which was advising keeping 2 Credit cards. I mean why? keeping more than one credit card may be good for a few people but not all. Keeping an eye on credit card expenses is right but if you are living in countries like the United States, it is not right. Credit is their lifestyle. But so does the risk coming after that. Another thing is Not using it rightly. Using some credit lines below the limit is not right
Keeping more than one credit line is great. Like, Auto loans, Home loans, Credit cards, and education loans. But among this, what is your debt-to-income ratio? is the EMI amount under control for you or it is looking difficult for you? another thing is Home equity. Indian readers may not be aware of it but US readers may well be agreed.
Sometimes we received Windfalls. Big one-time amount. Using them to reduce debt burden is the right move. Such opportunities are not coming every day. Utilizing that for any other reason may look good for a short period but increase the cost.
