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Credit Report – 5 Important Factors That Decides Your Credit Score

Credit Report is one of the biggest mysteries for borrowers or loan seekers. There is a common misconception that Credit Report is based on some mathematical calculations. The answer is No, It is not correct that credit report is only based on mathematical calculations. The credit score in a credit report is based on the calculations. But no one knows the formula of these mathematical calculations. Your credit report reflects the credit behavior and credit score is one of the criteria. The loan/credit approval is decided by the mix of credit score + credit behavior.

Sometimes high credit score in credit report does not reflect the correct picture. I shared the same in my post, Why High CIBIL Score does not guarantee Loan or Credit Card. In other words, the loan/credit is rejected in case of high credit score but poor credit behavior. The reverse scenario is highly unlikely and for loan approval min credit score of 700 or more is a must. The reader’s of the blog keep writing to me to share more inputs on credit behavior. Therefore, this post is dedicated to 5 important factors that decide your Credit Report.

As i keep sharing that your Credit Score is impacted by more than 70 factors. Now you much be wondering i cannot manage so many factors and may give up all the hope to improve CIBIL Score. To clarify, not all the factors are equal. There are five most crucial factors and are first among equals. We will discuss these 5 factors in this post that impact your credit report the most. Most of the other factors that impact your credit report are derivatives of these 5 factors only. Let’s check out

Credit Report – 5 Important Factors That Decides Your Credit Score

1. Payment History:

In layman terms, payment history is credit behavior. It is captured as Days Past Due or DPD in Credit Report. Last 36 months history is available. There is a common misconception among borrowers that poor payment history will be erased in 36 months time. It is not correct. If the account is closed after payment default then preceding 36 months entries are recorded in a credit report. Alternatively, if the amount due is not cleared then against each corresponding month the DPD entries are updated based on the info shared by the banks.

Though DPD reflects recent payment history but the status of closed or historical accounts also throws light on payment history. For example, a Settled or Written off  account means poor payment history. You can always take advantage of CIBIL Masking facility to correct your payment history. In my opinion, the credit bureaus give maximum weight to payment history and related factors.

Another common query on my blog is how long does it take for good payment history to reflect. Let me clarify that it takes minimum 6 months to 9 months for any changes in credit behavior to reflect in a credit report. Normally a borrower confuses this with the time to report a transaction/event like the closure of account in Credit Report. The time to report a transaction is 45 to 60 days. On the other hand, the behavior means consistency, therefore, time taken is 6-9 months.

2. Total Credit and Credit Utilization:

I covered this in detail in my post, Low CIBIL Score – Check your Credit Utilization. Here i would like to answer another common query on my blog how to find my creditworthiness. Based on my experience, i can say that the calculation of credit worthiness is different for secured and unsecured loans. For unsecured loans, your creditworthiness is approx 5-7 times your monthly salary. For example, if my monthly take home salary is 1L then my cumulative credit limit on credit cards, personal loans cannot exceed 7L.

On the other hand, for secured loans, the creditworthiness may depend on the interest rate. Assuming approx 10% interest rate and monthly take home salary as 1L then my credit worthiness for secured loan should be approx 50L. Please note following 2 important points.

(a) As a thumb rule, max EMI across secured and unsecured loans cannot exceed 50%-60% of the monthly take home salary. Therefore, the creditworthiness of secured and unsecured loans may change depending on the type of credit availed. In one of my post, i suggested that in order to increase the home loan eligibility you should close all unsecured loans.

(b)  The credit utilization of unsecured loans should not exceed 30%. In the example shared above if my credit limit of unsecured loans is approx 7L then my billed and unbilled credit utilization should not exceed approx 2.1L.

3. Length of Credit History:

This point is bad news for potential borrowers who never availed any credit/debt. Therefore, their credit score will be either NA or NH. New borrowers, who somehow managed to get credit/debt being a corporate employee or premium customers, as i shared in my post, How to read CIBIL Score? their score will be between 1 to 5.

Banks or financial institutions prefer borrower profile with long credit history in the credit report. It helps them to conclude better i.e. probability of a default by the borrower. Moreover, credit/debt experience of a borrower helps in credit/debt management. A new borrower may not be able to handle debt or credit thus may default. A recent study proved this point that probability of default is high in case of first-time borrowers.

It’s a catch 22 situation for new borrowers similar to freshers seeking a job. If no one will lend to new potential borrowers then how will they create the credit history i.e. the length of their credit history will always be Zero Months. In reality, it is not the case. The banks are becoming smart and finding out news ways of risk assessment. In my opinion, social media will be a great tool in future. One of my friend in the USA shared an example how bank rejected loan application based on bank’s conclusion from social media profiling that the borrower is an impulsive buyer.

4. Recent Credit availed:

I highlighted credit hungry behavior in some of my posts. Basically, i referred to recent credit availed. As you must have observed in savings account that if your normal withdrawal/deposit from/in a bank account is around Rs 30k to Rs 70k per month. Suddenly, one fine month you deposit/withdraw 5L from your bank account. I can give it in writing that you will receive a call from the bank to check the reason.

Similarly, i have normal credit behavior that is observed by the banks and suddenly if i avail 2-3 loans. It means i am not able to manage my money and is in some sort of financial crisis. The banks and financial institutions will become cautious. If i apply for another loan or credit facility then in all probability it will be rejected by the bank because of credit hungry behavior.

Here the term recent does not mean last 1 week or 1 month but last 1 year or more.

5. Demography:

Have you ever noticed that the premium of health insurance, motor insurance, home insurance etc may vary from zone to zone. For example, if i stay in Delhi then my health insurance premium was shown higher compared to when i selected Mumbai or Bangalore. The insurance companies have their own internal risk assessment based on demography. In other words, the zone in which more people fall sick or the zone that is more prone to accidents etc.

Similarly, when you apply for credit/debt facility the banks have their learning based on the demography. Based on my personal experience with my clients and readers, the borrowers in Mumbai are least likely to default. Therefore, if you are applying for a credit card and stay in Mumbai then the probability of approval is high on this factor. Similarly, banks do not prefer to issue credit cards in semi-urban and rural areas. Though i have lot of observations to share but as it is controversial point, therefore, that’s it from my end :)

Words of Wisdom:

The credit report and its calculations are not as simple as 2+2=4. The potential borrowers should check their credit report keeping the 5 factors shared by me in consideration. You cannot do much on demographics because if i stay in Delhi then i can’t change my city to avail credit/loan. As i highlighted in some of my posts, the preparation to avail credit/loan/debt should begin a year in advance. If at 11th hour you find any anomaly in your credit report then nothing much can be done. On safer side, you can take a period of 9-12 months for any good credit practices to reflect in your credit report thus improve your credit score.

Copyright © Nitin Bhatia. All Rights Reserved.

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