Understanding the power of credit scores

Credit reports and scores play a significant role in your ability to attain financial goals. A credit score is used to evaluate an individual’s creditworthiness. Generally, the score is a 3-digit numeric summary of your credit history. It is based on your 24 to 36-month credit history. Individuals with higher scores tend to have better access to financial products and services, while people with lower credit scores end up paying higher interest rates besides denial of certain financial products.

Banks and financial institutions across the world use the credit score as a tool to evaluate personal finance proposals. Honesty, integrity and past credit behavior are the most important things they consider more than anything.

The repayment history (35 per cent), how much you owe (30 per cent) length of credit history (15 per cent) type of credit (10 per cent) and new credit (10 per cent) are generally used to arrive at the credit score.

A score of 750 and above shows responsible credit management. A higher credit score, as mentioned earlier will help an individual to get higher credit limits faster at relatively cheaper rates. This also helps to get flexible repayment terms and enhancements and opens the door for preferential financial products in the future.

Let us examine how a higher credit score benefits an individual on the pricing front. A & B approach a bank for a mortgage loan of say $500,000 for 30 years. The credit score of A is 800 while the score of B is 600.

The Bank may offer a rate of interest of 5 per cent pa for A while B may be charged at 6 per cent p.a. The EMI for A will be $2684 and for B it will be $2998. While A has to pay a total amount of $966,279 during the 30 years, B will end up paying $1,079,191.

HOW TO IMPROVE YOUR CREDIT SCORE

It is very clear from the above illustration, how important is a higher credit score. You can improve your credit score by maintaining a good credit history. A few strategies are discussed here:

Foremost is the importance of paying the dues on time, as late payments are viewed negatively by the lenders. Secondly, use your credit limits judiciously and try to keep it as low as far as possible, if necessary go a higher limit and keep the utilisation low. Thirdly, try to have a proper mix of both secured and unsecured loans. Too much of unsecured components viz credit card limit, personal loans, etc may adversely affect the score. Lastly, periodically review your score and ensure that no mistakes are there in the score.

Various agencies provide the credit score in each country. In Oman, Mala’a (Oman Credit and Financial Information Centre) is an independent agency under the supervision of the Central Bank of Oman that gives the report.

Mala’a provides Credit Reports for individuals and Corporates. The report contains information such as the probability of defaults, bounced cheques and guarantors.

Credit Information Bureau (India) Limited (CIBIL) is the most popular credit information company operating in India. CIBIL reports are mandatory for availing credit facilities in India.

It may be noted that there are Credit Rating Agencies to evaluate the creditworthiness of corporates, business entities, governments and other organisations. The rating varies from AAA to D, while the Credit Score is for individuals that vary from 300 to 900. The purpose of both agencies is the same.

The credit score is getting important.

Indian banks are now insisting on the Credit Score of Indian nationals working abroad for evaluating their credit proposals. Indian expatriates in Oman are asked to submit the Mala’a report.

Therefore, financial discipline is very important. Remember, credit score is not limited to banks alone. Other organisations like, hire purchase companies, digital finance companies and government departments are using the techniques to assess the creditworthiness of individuals.

In short, a high credit score is valuable when seeking personal finances. Understanding the importance of it can help you to make smarter financial choices. By proactively building your score, you empower yourself to a better financial future.