Whenever somebody wants to get a loan, their credit score is checked. Simply put, a credit score is a number between 300 to 900, given to every loan applicant by the lending institution. Better the score, the more the chances of approval.
How do banks assess if the borrower is worthy of the loan or not?
Today, we’ll try to address this question.
The parameter of whether the borrower will get a loan or not is termed creditworthiness. It denotes your loan eligibility, contingent upon your financial background and credit history.
If your credit score is low, lenders consider you high risk and charge higher interest rates. But if your score is 750 or higher, you’ll enjoy better rates and lower EMIs.
Now, let’s dive into how financial institutions evaluate creditworthiness.
There are 5 Cs of credit assessment.
Character: Lending institutions closely examine your personal and financial background, including your credit history. That is a way to measure trustworthiness and reliability as a borrower. A solid credit history and a responsible financial track record can boost your chances of loan.
Capacity: Capacity refers to your ability to repay the loan. Lenders assess this by calculating your debt-to-income ratio (DTI). They compare your total monthly debts, such as existing loan payments and credit card bills, to your gross monthly income. A lower DTI ratio indicates a higher capacity to handle loan repayments, which enhances your creditworthiness.
Capital: Capital reflects your financial strength and resources. Lenders want to ensure you have enough money to repay the loan, even during financial stress. They may consider your savings, investments, and other assets to assess your capital and ability to fulfill your loan obligations.
Conditions: Conditions encompass various internal and external factors impacting your ability to repay the loan. Lenders consider your employment history, job stability, industry trends, and overall economic conditions. These factors provide insights into the conditions that might pose risks or opportunities for your loan repayment.
Collateral: Collateral refers to assets that can be used as security against the loan. Lenders may require collateral, especially in the case of secured loans or for borrowers with a higher risk profile. Collateral provides lenders with protection if a borrower defaults on the loan. It can be in the form of property, vehicles, investments, or other valuable assets.
Now you know why credit score or CIBIL score is so important and difficult to maintain. If you are facing some difficulty in maintaining a decent credit score, here’s how you can improve the score.
- Pay all dues on time: Timely payments build a positive image among lenders.
- Avoid multiple loan applications: Applying for multiple loans quickly can lower your credit score and raise concerns for lenders.
- Maintaining a good credit mix: Balance secured and unsecured loans to show reliability.
- Check your credit report for errors: Regularly review your information and promptly report any inaccuracies to the credit bureau.
- Keep credit utilization low: Minimize unnecessary spending and maintain a credit utilization ratio below 30%.
Understanding credit scoring is crucial for loan applicants as it determines their creditworthiness. By maintaining a good credit score, borrowers can improve their chances of loan approval and secure competitive interest rates.