Saturday, May 31, 2008

How High Is Your Score?

Every borrower seeks the lowest interest rate, every lender the highest. The return a lender seeks factors in, apart from his profit, a premium for the risk he feels he bears of not being paid back. This risk perception is different for different borrowers and, ideally, should be determined from their credit history. But, till recently, lending banks had only their own experience with an individual to fall back on for this assessment. That is changing now with the entry of agencies that assess the creditworthiness of people like us.

Now, a lending bank can source your credit score from agencies such as Credit Information Bureau (India), Cibil for short, to supplement the information you furnish in your loan application. Cibil, in a tie-up with TransUnion of the US, launched the first generic credit score in India in November last year. Others have followed—Fair Issac Corporation in a tie-up with High Mark Credit Information Services, and Equifax in association with Crisil and Tata Capital.

Now, if you default on a loan from one bank, it will bring down your credit score, which any other lender that you go to will also be privy to. And it could determine not only whether you get a loan, but also the rate of interest you pay on it. So, it is important that you learn how to keep your credit score high.

What is a credit score? A credit score takes a ‘snapshot’ of a consumer’s credit report and through advanced analytics turns the information into a 3-digit number representing the amount of risk he brings to a particular transaction. For instance, the Cibil-TransUnion model gives scores ranging from 300 to 900. The higher the score, the lesser is the risk of the consumer going 91-plus days overdue in the next year. While credit scores are new to India, the US has had them since 1989, when the FICO scores were launched. The lines of credit assessed to arrive at this score would mainly be retail products like home loans, auto loans, personal loans, credit cards and overdrafts.

What’s a good score? In the US, a FICO score of more than 700 is considered excellent. In India, however, credit scores from Cibil-TransUnion have been around for just four months and it is yet to be ascertained what a good score is under its model. Arun Thukral, managing director, Cibil, puts forward another view: “Whether the score is good or bad will depend on the bank’s internal policy, its customer profile and its risk appetite.” He explains further that some bank may perceive 700 as a good score and another may not. Thus, in India, different banks will rank different scores as good. Still, any score over 800 will be considered excellent across the board. Thukral says the Cibil-TransUnion score will only be indicative and serve as a tool for managing risk. “How a bank uses the risk management tool is its internal decision,” he adds.

How have lenders responded? Thukral says that banks have welcomed the concept enthusiastically. “Banks realised that an objective thing like the credit score will not only help them reduce defaults but also make loan disbursing faster, improve operational efficiency and bring costs down,” he says. In fact, banks have started using the score as one of the major factors for deciding the creditworthiness of an individual.

Thukral also explains how an independent credit score is an improvement on the score that banks arrive at through their internal systems, “Banks will have information only about their own portfolio; a borrower considered good by one institution might not behave the same way with another.”

How to get a good score. The scoring model used by Cibil-TransUnion employs multiple attributes. The weight it gives to each of these attributes is proprietary information.

Credit utilisation. One of the most important determinants is credit utilisation, that is, how much credit is the customer using. For instance, if you can safely borrow Rs 1 lakh, but go for a loan of only Rs 50,000, then you are a very safe candidate. It also means that you are not overleveraging.

Payment history. This is extremely important. The first question that is addressed is: has the person involved ever defaulted on his payments? If he has, it is examined in how many accounts defaults occurred, by how many days and by how much. Earlier, even one instance of default turned you into a bad customer. Today, an otherwise good repayment history can offset the blemish of a default due to unforeseeable reasons. “It is not that two defaults in the entire repayment tenure will create a permanent scar on your credit history,” says Thukral.

How To Manage Your Credit Score
I. Credit utilisation

How much credit are you using?

If your safe limit is Rs 100 and you are using only Rs 50, then you are a very safe customer. If your limit is Rs 100 and you are not only fully using it, but also seeking further credit, you could be overleveraging yourself and your score could fall.

Are the number of enquiries very high? Have you applied for additional credit lines, recently? Unnecessary and frequent shopping for credit or too many new accounts can be taken as an indicator of being over-hungry for loans and impact the score negatively.

II. Payment defaults
How many past accounts are due, by how many days and by how much? The fewer the better.

III. Trade Attributes

How old are your lines of credit and what type are they? Do you have a good mix or is it, say, all credit cards?

A history of consistent repayment of various types of credit will improve your score.


I. Evidence of financial discipline.

II. If you have defaulted once or twice due to reasons beyond your control, these should show up as clear aberrations in an overall consistent payment history.
III. The longer your credit history, the better. The lender’s assessment presumably improves as he gets bigger spans of repayment. Be judicious about closing old accounts and opening new ones.

Score range: 300-900

Good score: 800+ (this will, however, vary from bank to bank)

Source: Cibil

Craving for credit. Frequent and unnecessary shopping for credit, and several new accounts or recent requests for loans can be taken as signs of an over-hungry borrower. That could bring the score down. The length of credit history is also important. Older accounts are generally better, so you should be judicious about closing old accounts and opening new ones. And, finally, there are the trade attributes—does the customer use a good mix of credit?

Broadly, the wisdom is old. Maintain financial discipline, repay dues on time and do not overleverage yourself.

Using your credit score. Technically speaking, you cannot use it. As it is early days for individual credit scores in India, the data is available only to lending banks. Unlike in the US, you cannot find out your score and, therefore, cannot flash it to the bank official and demand a more favourable interest rate for yourself. But scores are expected to be made available to the respective individuals soon. That said, you must remember that the scoring process is already on. So, even if you cannot see your score, it will pay to try and keep it high. Keep watching this space.

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