Borrow if you must, but have a clean credit score
Do you remember your classmate from your schooldays who would always take money from other classmates and then never pay back? What would be his/her reputation? And would you feel comfortable lending money to him/her?
People like this classmate would find it virtually impossible to get a loan for buying a car or a home. There is now a well-organised and institutional way to track the repayment record or credit behaviour of both good and bad borrowers.
Your credit history is accessible to lenders and can affect whether you get a loan on more favourable or more difficult terms, or if you can get a loan at all. Here we share with you details of the changes sweeping the credit landscape in India, why they are important for you and how you can benefit from this.
Changing landscape of the credit industry For the economy to function smoothly, it is important that consumers have access to credit. However, borrowers must pay their EMIs on time as well as ultimately pay back their loan on time. Otherwise, the entire consumer economy could collapse. In India, most of us take a loan to buy a car, buy a home or to purchase consumer items such as refrigerators, television or to enjoy a foreign vacation. As things stand, all borrowers generally pay the same interest rate irrespective of whether we have a good track record or not. This is about to change. Two dynamics are at play that will affect our ability to get loans and the interest that we pay on them.
First, starting July 1, according to RBI guidelines, banks will price their loans using a Base Rate. To this Base Rate they will add a risk premium which will be specific to the kind of risk that the bank perceives you to carry, based on your creditworthiness. Your classmate from school with a bad reputation for borrowing money will most likely be charged a higher risk premium because of his/her ‘tainted’ history.
Secondly, banks are increasingly accessing your ‘credit history’ or your past records if you have taken loans and analysing how disciplined you have been to pay them back on time and in full. Specialised institutions called credit bureaus have been authorised by the RBI to be set up to be a repository of factual data on your track record of your timeliness in paying your loans including credit card borrowings, history of your cheque bounces and the number of applications you make to access credit (whether through credit cards, personal loans or other types of loans). Lenders can access reports available from these bureaus and on the basis of this interpret your track record to decide whether they want to lend to you or not and on what terms.
How does my credit history impact me? Those borrowers, who have a good history of paying back their dues on time and in full, can benefit in two ways.
First, they will find that their loans are processed faster and can be disbursed faster because the lender might have lesser doubts or concerns on such borrowers.
Second, those with a good credit history will be seen as lower risk. They will find that they can get loans on better terms, especially slightly cheaper interest rates. Those who have historically had a bad record of managing their loans and repayments will find that their past behaviour can adversely affect their ability to get loans in the future.
Let us take the case of a young 25-year-old man who takes a personal loan for Rs 10,000. This person has a rather casual attitude towards paying the loan back. In fact, he moved to a different city with a new job and then decided not to pay his dues because he felt it would be hard for the lender to track him down in his new job and city. However, a credit bureau can centrally track this person’s credit behaviour and can share this negative information with lenders across India who might be considering this person for a loan in the future.
For instance, as this person grows older and needs to apply for a more important loan like say a Rs 4 lakh car loan, or a Rs 15 lakh home loan, he might find that lenders are not willing to consider his application, or will only consider it on terms that are very harsh. All this because he lacked the discipline to pay back the relatively small amount of Rs 10,000.
It is worth noting that an individual’s credit history can be interpreted differently by different lenders, depending on their own criteria and their internal risk management policies. So while one lender can reject an application looking at your credit history because they don’t want to take the risk of lending to you, it is quite possible that another lender might be comfortable lending to you. It is all a matter of interpretation of your factual data that comprises your credit history.
What if I am a first-time borrower? Many of us might have never taken a loan in the past, and so don’t have a credit history. Does this hurt us because a credit bureau has no prior information on us? The short answer is no. However, it might be worth your while to start building a track record for any future loan applications you might make. Even if they are small transactions you conduct using a credit card, as long as you pay your card dues back in time and in full, you will find that this will help build your credit history on how disciplined you are in dealing with paying back your loans.
Where can I check my credit history? Credit bureaus such as CIBIL or the recently set up Equifax India capture credit information that their member firms share with them on your past loan transactions. For the payment of a small fee you can also access your report from these bureaus and see what kind of a credit score are they assigning to you.
If you wish to dispute a particular instance in your history that has been incorrectly reported, you can approach the specific lender with whom the transaction in question was conducted, and request them to rectify your record with the credit bureau. The authors are co-founders of iTrust.in, a leading financial advisory business.
