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what is credit score and how does it work?

what is credit score and how does it work?

December 30, 2021
10 min read
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we're often told that it's crucial for us to maintain a high credit score. the message isn't lost on many Indian millennials, with Transunion reporting an average CIBIL score of 740 among the generation.
a high credit score has a significant impact on your ability to use various financial services and benefits, so keeping a close eye on it is an all-time affair. 
but before we jump into the details, let's take a closer look at what a credit score actually means and why it's important.

the basics of your credit score

your credit score, simply and most commonly put, is a three-digit number representing the creditworthiness of an individual. it ranges from 300-900. the lower levels reflect low creditworthiness and the higher levels reflect higher creditworthiness. 
CIBIL, or the Credit Information Bureau India Limited, states that the ideal credit score is any value that's above 750. in fact, according to CIBIL's own website, 79% of loans are sanctioned to customers who have a CIBIL score of above 750. 
banks always check this score to find out whether or not you'll be able to repay it despite the burden. so you must maintain a score higher than 750 if you are to be able to avail loans and other benefits when you need them.

understanding credit score ranges

various factors can affect your credit score—thus placing it in multiple brackets. 
where your score stands will heavily affect your banking activities. consider your credit score as being your way of making an excellent first impression when dealing with your banks. 
so let's dive in and understand these ranges, starting from the highest to the lowest.

credit score range


750 and above - great

a credit score of 750 and above puts you in the highest bracket of the range. this bracket comes with a whole host of benefits. the most important is that it leaves you eligible for a quicker and easier approval process on your loans, along with lower interest rates.

700 - 749 - good

a credit score between the range of 700-749 is good, and can still get you great interest rates with a relatively quick approval process. however, always target the highest bracket as it makes the entire process a breeze.

650 - 699 - fair

a score that lies anywhere between 650 and 699 is considered average or fair. loans for individuals with a credit score in this category can still work in their favor, but it's undoubtedly a balancing act at this point. various factors can affect when it's approved at this point, including your debt burden from other loans if any.

600 - 649 - poor or highly doubtful

when your credit score lies in the range between 600 and 649 is when you're veering into dangerous waters. at this point, any loans that are approved will be sanctioned at a high-interest rate, significantly increasing your debt burden.

below 600

a credit score below 600 needs immediate action. the likelihood of a loan being approved to you at this point is almost negligible, and even if it is, it'll be at the highest of interest rates. this is when you will really need to step into action and work towards increasing your score as a poor value will hardly be of any help.

what factors affect your credit score?

going through the details of these ranges can be a daunting affair, especially if your score is on the lower end of the spectrum. 
this is where this guide will come handy, as you undoubtedly want to increase your credit score. doing so will get you several privileged benefits that a low score won't. 
here are some factors that will affect your credit score: 

an imbalance in your debt to income ratio
your debt to income ratio is possible among the most important factors that affect your credit score
it's advised that you keep your debt, such as any mortgages, loans, credit card bills, and so on, to less than 50% of your income. this assures banks that you aren't spending all your income paying for past debts and that you can repay a new loan. 

payment history has a high impact
your payment history is a pivotal factor that determines your credit score, which in turn affects your ability to get loans approved quickly and at lower rates of interest. 
if you've paid all your past loans or EMIs on time, this will reflect positively and will send the message that you're much less likely to default on any new loan sanctioned to you, and as mentioned above, will get you lower rates of interest. 
late payments, on the other hand, can affect your score by several points. 

exceeding your credit utilisation ratio
this is the second biggest factor that can affect your score. your credit utilization ratio refers to the proportion of the overall credit available to you that you've used. 
ideally, one must not exceed using 30-40% of the credit available to them if they want to maintain a higher score and thus avail other privileges when applying for loans. 

the age of your credit matters
older credit can play a crucial role in determining your score. if you've been responsible in the past with your credit, this will positively reflect when banks are considering whether or not to sanction a loan to you. 
longer credit that's been dealt with responsibly with timely payments of any dues is crucial as it assures the bank of your commitment to repaying any loan sanctioned to you within the stipulated deadlines. 
this is what makes older credit cards more critical as opposed to more recent ones that don't paint a comprehensive picture of your behavioral patterns. 

multiple loan enquiries can harm your trustworthiness 
banks will often consider it a red flag if you've applied for multiple loans at the same time, as it puts into question your ability to repay your heavy debt burden. 
you must be cautious when applying for multiple loans; don't apply for a loan that you can't repay in time as it will further affect your score. 

a healthy balance of credit
while not the most crucial factor, banks often consider your ability to responsibly handle different types of credit. these are usually secured credit (home, car loans) and unsecured credit (credit cards). 
if you've managed to ensure that all payments in the past have been paid off promptly, it can undoubtedly have a positive impact on the bank's willingness to offer you a loan at a cheaper interest rate.

how can you improve your credit score?

if you're feeling genuinely hopeless about your prospects of a stellar credit profile, don't be. you can improve and bring your credit score above 750 in several ways. doing so opens a world of possibilities that you won't have access to with a lower score. 
track your credit report to rectify any errors
at times, credit score reports may have made the mistake of not updating a loan you've already repaid. this can affect your credit score quite a bit, so keeping track of your reports to spot such errors is crucial. you can accordingly approach them for a correction. 

repay all your debt in time
repaying all your loans and debts in time is the ultimate bastion of hope for those who want to portray themselves as responsible, creditworthy individuals. this element is what banks rely on when deciding whether to sanction you a loan and at what rate of interest. 

opt for long-term loans
while the urge to repay your loans as soon as possible can be strong, if you're unsure, always opt for a longer repayment period. this will mean that your monthly installments are also lower, making it easier for you to repay without the worry of defaulting on one. 

the older the credit card, the more valuable it is
do not get rid of your older credit cards, even if you feel like it's time for a change. if you've had a positive credit history, your credit card is the means for a bank to determine that you're a responsible customer.

what is the advantage of having a good credit score?

there are various advantages of having a good credit score. few of them are:

  • low interest rates when you subscribe to a credit card or loan
  • a more profound chance to get your loan sanctioned
  • eligible to acquire a higher amount of loan
  • eligible to make your credit card bill payments from apps like CRED, through which you can pay your bills hassle free and win rewards and CRED coins for the transaction

final thoughts

from the day you open a bank account, it's essential that you keep a close eye on your credit score. a good score is the coveted key to unlocking various financial privileges that you'd otherwise be missing out on. 
avoid stacking up debts, pay all your dues on time, and you'll be well on your way into a financial journey that gives back more than you take from it.