Banks create a credit profile of every person who approaches them for a loan. This is a very vital part of any loan application process and banks do consider it very seriously before sanctioning any kind of loan.
What is a credit profile?
Based on the income, education, residence, age, employment, nature of job (whether salaried or self-employed) and other parameters, a bank creates a profile of the loan applicant, which helps it in establishing the credit-worthiness of the concerned person.
The whole idea of this exercise is to judge whether the applicant is a suitable candidate for the loan in question and if s/he will be able to repay the loan back with interest in the stipulated time frame.
If an applicant has a previous credit history, it becomes a major tool for the banks to judge the credit profile. A person who has taken a loan earlier and has satisfactorily paid it back, creates a positive impression. That's the reason credit card holders with a good repayment record are given loans with minimum hassles.
On the contrary a person with a poor repayment record will form a negative image. This is also applicable for persons who haven't taken any loan and do not possess a credit card.
How does a credit profile affect interest rates on loans?
Banks provide detailed eligibility conditions with every loan product. The closer a borrower matches these conditions, the better will be the interest rates and loan terms. Having a consistent employment in a blue chip company, MNC, public sector undertaking, government office or a reputed private company will get a borrower low interest rate loan.
The further you deviate from these established norms the higher will be the interest rates.
The amount of salary one draws, determines the repayment capacity of an individual to a large extent. Banks generally give a personal loan of 10 times the monthly salary. So, if a person has a monthly salary of Rs 50,000 banks will happily provide a personal loan of Rs 5 lakh provided s/he meets other eligibility requirements.
On the other hand a person with a monthly salary of Rs 25,000 will find it difficult to get a personal loan of Rs 5 lakh.
How can one improve her/his credit profile?
The first thing is to find out the eligibility requirements for a particular loan product. Now go through these details and mark the things where you deviate from this profile. It could be age, income or employment etc. Finding a suitable guarantor or co-applicant who can fulfill the eligibility requirement completely will help you improve your credit profile.
For example: If you are salaried person and over 60 chances are great that to get a loan you'll have to improve your credit profile with a suitable guarantee or a co-applicant who is well employed and retires after the loan is paid off completely.
Similarly, if the minimum monthly income requirement for a loan is Rs 25,000 and the borrower's salary is Rs 15,000 per month, she can club the income of her/his spouse or daughter/son and improve her/his credit profile.
An excellent credit profile that matches the eligibility requirement of a bank is the key to getting the best interest rates and other terms on a particular loan product, and it should never be overlooked.
In foreign countries, there are typically independent credit rating agencies which keep a track of every individuals credit profile and risk profile. These are companies like CIBIL, Equifax, Experian which collect data from various banks and consolidate the data of each individual and give out something known as a credit score. A good credit score is essential for getting loans at a cheap interest rate, new credit cards, insurance, etc.
Illustration: Uttam Ghosh/Rediff.com