Previously, we understood what a Credit Score is and how it is calculated. Also, how Credit Scores can be used advantageously by both the borrower and the lender to figure out the best terms for getting a loan. If you have not already read it, you can click here: What is a Credit Score and how does it work?
As mentioned earlier, the Credit Score is a reflection of the creditworthiness of the borrower. A higher score typically indicates a more reliable borrower, i.e., one who is likely to repay the loan amount and monthly installments in a timely manner. The advantages of having a good Credit Score are manifold, and here are the top reasons why you should maintain a good score.
- Impact on Future Borrowing: A Credit Score is a composite of the borrowings you have taken in the past, and if you have paid them on time. If you have made timely payments and cleared your loans in a timely manner, lenders are more likely to extend further loans of higher value to you in the future.
- Impact on Available Credit: If you maintain a good track record of payment and do not utilize credit cards to the limit, banks and lenders are likely to offer you extensions on the present credit limits as well. For example, a credit card holder who repays his credit card bill in full before the due date and does not use more than 50% of the credit limit will usually be offered an increase in credit limits or a higher category of card with more rewards and benefits such as loyalty points, cashback, etc. Since future borrowing limits are also a factor of the level of credit presently available, having a good Credit Score now ensures that you have access to more credit at reasonable rates in future, as well as improving on the Credit Score further.
- Impact on high value purchases: In India, loans are most required for big ticket purchases like buying a house, a four-wheeler or for business purposes. Since these are all transactions where the quantum of the loan is large, a higher Credit Score can ensure the borrower of more favorable repayment terms such as lower interest rate and longer repayment tenure. This can be significant for items such as home loans where a one percent reduction in the interest rate can save lakhs of rupees across the repayment tenure of the loan.
- Provision for Contingencies: One of the largest impacts on the credit score is from the borrower’s utilization of the available credit, such as on credit cards. If the Credit limit utilized is low, the borrower has a higher credit score and can therefore borrow more at times when there may be an emergency or similar need. Alternative options are also available at such times. For example, if the borrower wishes to take a loan for higher studies and an education loan is not immediately approved, a personal loan could be taken as a temporary arrangement. However, these options are restricted in case the credit score is not sufficiently high.
- Long Term Financial Health: A good credit score in the long term indicates a person who has a good control over his or her borrowing and spending habits, and therefore represents a financially sound entity. As long-term credit relationships evolve, borrowers can also get access to good investment and savings opportunities in areas such as insurance, mutual funds, etc. which improve the financial relationship of the borrower with the banks and generates good returns as well.
“Today, financial institutions evaluate factors such as the total relationship value of the customer with the bank and the tenure of that relationship, along with the Credit Score. While the Credit Score is an important factor in determining the creditworthiness of the individual, it is also useful for opening other financial opportunities in investment. So, maintaining a good Credit Score is an important aspect of one’s long term financial success as well” says Manish Tiwari, Business Head – Commercial Equipment Loans at HDB Financial Services.
So, make sure you maintain a good credit score and build a sound financial future through the judicious use of credit. In the next part of this series, we shall look at the various ways of improving your credit score in both the short and long term.