If you need a loan to buy something you cannot fund immediately, you approach a financial institution—typically a bank or a non-banking financial company (NBFC). When you do that, the financial institution runs a background check on you, from its own database (if you are an existing customer) and also from a credit information bureau. The credit information bureau is authorized by the Reserve Bank of India (RBI) to gather information on loans and borrowers from banks and analyse it to arrive at a score of creditworthiness of an individual. If your creditworthiness is good, you would get a loan relatively easily and at better terms. If not, either the loan will be rejected or you will be charged a higher interest rate. This is especially true in case of personal loans. The institutions’ decision to lend is based in large measure on the credit score and the credit report.
What is a credit score?
It is a number based on your credit report, which is a summary of your past and current borrowing and repayment history. If you were regular with repaying loans, including your credit card bills, your credit score is likely to be higher. This score helps banks assess your loan repayment capacity and your chances of defaulting on it. “Credit score is derived from the credit history of an individual. A consumer needs to have a minimum of 6 months of repayment track record on a loan or credit card or closed credit accounts less than 2 years old before a credit bureau can generate a credit score,” said Hrushikesh Mehta, vice-president and head of direct-to-consumer business, TransUnion CIBIL. A credit score is created as your lending and repayment relationship with financial institutions evolves. However, if you are new to credit, here are some ways you can quickly start to build a credit score.
Credit cards or personal loans
If you are new in the workforce, you can start by getting a low-limit credit card from the bank where you have a salary account, said Sumit Bali, senior executive vice president and head-personal assets, Kotak Mahindra Bank Ltd. “Based on their income, banks can give them a card with low limit. Use that card sensibly and build a credit history,” he said.
In the past, people considered taking personal loans to build their credit score. However, with a personal loan you will necessarily have to spend your money in paying the interest, whereas with credit card repayments within the stipulated time, you do not have to shell out extra money. For slightly older professionals, about 35 years old, credit history is not much of a worry if their bank account status and average balance are good, and investments and tax returns are in place. They “don’t really need a credit card to prove credit worthiness. Any bank would sensibly look at it and take a call,” Bali said.
Peer-to-peer (P2P) lending platforms are an emerging option for creating and enhancing your credit history. The RBI has recognized these platforms as special category NBFCs and has mandated them to share lending data with credit information bureaus. “Once the P2P lenders receive their licence, they will be able to begin data submission. Once that happens, P2P lending will become a viable option in helping one build a credit score,” said Mehta. However, in this case too, you will have to pay an interest on the borrowed amount.
In some cases, especially where customers have a long relationship with their bank, the banks may also look at own data to determine creditworthiness, Bali added. “Credit score by and large is a good indicator but it may not be the only indicator,” he said.
Alternative credit scoring
Evaluating someone who has never taken a loan can be difficult. This is where alternative credit scoring comes in. Here, instead of relying on a credit score, lenders consider your transactions and behavioural data like bill payments, online buying behaviour and information from your social media platforms to understand your repayment capacity.
“Often people are refused big-ticket loans like a home loan for the lack of credit history, even if their finances are in order,” said Abhishek Agarwal, chief executive officer and co-founder, CreditVidya, a credit advisory that also works on alternative credit scores. (read more on it here
However, financial institutions including top public and private sector banks and NBFCs in India, have started using alternative data in multiple verifications and validations across the credit value chain, Agarwal said. “Innovative offerings like pre-approved offers or instant loans are leveraging alternative data from multiple sources to provide seamless customer experience,” he said, adding that leveraging alternative data for credit risk assessment of secured loans is still distant. Banks use the alternative scores “in conjunction with other things, like data that you have about the customer. This is happening for personal consumption products like credit cards and salaried personal loans. We are putting it to use but what is the outcome from that, it is too early to say,” Bali said.
While credit cards and loans help to build a credit history and score, caution needs to be exercised. If used carelessly, these can put you in a debt trap, and ruin your credit history too.
Not just that, you should also keep your digital and transactional behaviour in check, as going forward more and more data could be used to assign you a credit score.
Mon, Nov 27 2017. LiveMint
By Shaikh Zoaib Saleem