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7 steps to understand your credit score

By Rajiv Raj
May 03, 2016 10:03 IST
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Your credit score is more than just a number. Here's how you can read and understand its importance.

The financial era that we live in today is distinctly different from what the landscape used to be at least a couple of decades back.

Today, there is increased usage of credit and the younger generation is much more comfortable using credit as compared to their parents. Also the intense competition among banks has led to rampant advertising that leads youngsters to believe that credit is just an arm's length away.

What they don't tell you though, is that, while credit may be easily available, your CIBIL score is of primary importance right from the very beginning.

Every time you apply for a loan or a credit card, the concerned lender is going to be looking at your CIBIL score, and if it is not above the level of 750 (out of 900), your loan or credit application may even get rejected.

So if you have just stepped into adulthood and are eager to access credit, here are some tips that will put you ahead on the path to build a good CIBIL score.

Understand what goes into the making of CIBIL score

To build and maintain a good CIBIL score you need to first know what goes into making it. So here are the things that make your CIBIL score:

1. The repayment history

This is the primary constituent of your CIBIL score and contributes to 35 per cent of it. The ground rule for the usage of any credit is to make timely repayments. The best way to do so is to automate the payment process.

2. The credit utilisation ratio

This is another important constituent of the CIBIL score and contributes to 30 per cent of its constitution.

In layman terms, your credit utilisation ratio is nothing but the total amount of credit you use as opposed to the total amount of credit you have been authorised.

Financial prudence says that you should always try and keep your credit utilisation ratio at 30 to 40 per cent to maintain a good CIBIL score.

3. How old is your credit

The age of your credit is another factor that influences your CIBIL score and contributes to about 15 per cent of its constitution.

Although you are not expected to have a long record or credit history right from the start it is important to make timely repayments on your credit cards if you own more than one and not to close any of them at a later stage.

4. The mix of debt

This is a factor that contributes 10 per cent to the constitution of the CIBIL score.

It is advisable to maintain a good mix of secured and unsecured lines of credit in order to gain brownie points on this factor.

5. The number of hard inquiries

You may be surprised to learn that each time you make an application for a new loan or a credit card, the concerned lender makes a request for your CIBIL score and report. These qualify as hard inquiries. Each time there is a hard inquiry on your CIBIL report, your CIBIL score takes a hit.

Too many hard inquiries make you seem credit hungry and will make any lender wary of giving you a loan or a credit card.

Therefore, unless and until you absolutely need a credit card or a loan, do not apply for one.

6. Get you own credit card

One of the greatest ways of building good credit that leads to a good CIBIL score is by having a credit card. A credit card can be used as a means to build a good CIBIL score so long as you are spending in small amounts and making payments in full.

If you manage to maintain this basic financial discipline for the rest of your life, there is a good chance that you will end up having a good CIBIL score.

A good CIBIL score means that you will get access to cheap and timely credit as lenders would have the confidence of lending to you.

7. Choose your first card well and do not succumb to temptation

Credit cards come loaded with a lot of rewards and cashback offers; but those are not the only factors that should influence the rationale of taking your first card.

Make sure you carry out enough comparisons and choose the best credit card in terms of interest rates, fees and rewards that are most relevant to you. Once you have taken your card, begins your litmus test.

While it is easy to get carried away and overspend on your card, bear in mind that spending beyond your means is the first thing that leads to a debt trap. So the ground rule of using credit cards is never to buy anything on the card that you cannot afford to pay back in cash over the billing cycle.

Building and maintaining a good CIBIL score, is no rocket science, but often young people tend to fumble in their credit usage and that does considerable harm to their CIBIL scores. So just as you are conscious about your physical health and do everything possible to keep in ship shape, maintain financial discipline and you will see that your financial health is in order too.

Besides armed with a good CIBIL score you are most likely to get a loan or credit card whenever you are in need of one.

The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.

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Rajiv Raj