[This article explains on grading of borrowers who have a short credit history, how the credit score is calculated, factors considered for calculation of scores, the important aspects to see in the CIR]
The loan applicant’s credit scores work as the first impression for any lender. Normally, the lender would evaluate other details of the credit proposal, after confirming that the credit report of the applicant is positive. The credit information report (CIR)) of an individual shows the likelihood of default based on borrower’s credit history, present income, debt service obligations and credit scores.
CIBIL TransUnion Score 2.0 is the new version of the scoring system developed by CIBIL which is the largest domestic Credit Information Company in India. The upgraded scoring system of CIBIL has several supplementary factors which were lesser significance in the earlier scoring system. The revised version also helps the lender to credit appraisal of borrower’s proposals, who have a short credit history or no credit history, by grading them with risk index.
Grading of borrowers who have a short credit history:
In the earlier version of CIBIL, the individuals who have the credit history of lower than six months were categorized under “No History- NH” and the loan applicant is awarded a score value of ‘0’. In the new version, the people with no or short credit history will be graded the risk indexes from 1 to 5. The risk indexes one or two means high risk, three means medium risk and four or five means lower risk of default. In the other words, higher the index indicates lower the risk. Hence, the new feature of risk index will simplify the process of credit appraisal of first-time borrowers and people with short credit history.
How is the score calculated?
According to experts in the know of score allotting process, past performance of the individuals on their debt obligations is the most important factor for positive scoring. Good repayment history without any delay and default contributes approximately 30 percent weight age to the score.,
Additional 25 per cent weight age score is assigned to the type of loans taken and the duration of credit history established with the proper mix of secured and unsecured loans. The higher proportion of secured loans and prompt servicing of Long-term loans earns more points to a borrower. Whereas, shorter credit history and the higher proportion of unsecured loans will have the negative impact on credit scoring.
A block of 25 per cent scores earmarked for credit exposure of an individual. The aggregate quantum of borrowings including balance outstanding on credit card utilization determines the credit exposure of the applicant. High utilization of credit limits increases the credit exposure of the borrower, which would naturally reduce the ratio of income to spending and thereby reduces the credit scores.
The remaining 20 percent of scores are allotted on the basis of other issues like frequency of application for a new loan or credit cards, credit utilization, recent credit behavior etc.
The incidents of a borrower who got sanctioned multiple loans and credit cards at a short span of time impacts negatively on his credit scores as the same signals the behavioral change of the borrower associated with the increased debt burden.
When an individual applies for loan or credit card, the applicant’s credit information report (CIR) will be called for by the lender. If the applicant has made the calls at 4-5 banks at a time, CIBIL structure makes a note of such referrals as enquiries. The frequent enquiries for credit limits have a negative bearing on credit score. Further, past history of making late repayments of loan installments, over dues in the accounts, increased burden of repayment of debts etc. may negatively impact the scores.
Factors considered for calculation of scores
The basis of past performances, credit type, credit duration, credit exposure, and other issues like frequency of application for a new loan or credit cards all have the influence on CIBIL scoring. The three digit CIBIL TransUnion scores are calculated based on the information in the ‘accounts’ and ‘enquiry’ section of the report. The CIBIL builds up records of individuals on the basis of information reported to it by various lenders over a length of time. The credit scores are awarded to an individual in the range of 300 to 900 of scores. It is considered that the higher scores in the report, the chances of default is less. Generally, most of the banks accept CIBIL TransUnion score of 750 and above level good for lending (equated to 800 scores and above in the earlier version of scoring). However, the cut-off credit scoring for eligibility of loan may vary from bank to bank depending upon the individual bank’s loan policy.
The scores in the range of 300 to 600 always considered being the risky proposal by the lender, as it indicates past credit history of the borrower is bad. Since the chances of default are higher, in most cases, the credit proposals received from such borrowers are rejected by financial institutions without further process.
The range of 600 to 750 scores may not be either good or bad, as that implies that the borrower had difficulties in repayment of previous borrowings. Normally, the lender will be more cautious in lending against credit scores of this range. However, depending upon loan policy of the bank, the borrower may be asked to offer additional collateral security to offset the risk of default.
The important aspects to see in the CIR:
The high credit score itself does not indicate the payment behavior of the borrower. The CIBIL credit score is based on 24 months of credit history. Nevertheless, the credit information report shows the status of earlier loans and credit cards taken by the borrower. If the status shows “settled” or “written off” in the report of the proposed borrower/Director/Promoter, it is likely that the lender would reject such credit proposal because of the high risk involved in it. However, if “settled” or “written off” status found in the third party guarantor’s CIR, the lender may permit the borrower to replace such guarantor with someone else who is enough credit worthy.