There are many aspects on which your ability to get loan is affected. The main aspect is your credit score, along with the information on your credit report which will determine whether you’ll be able to get a loan or not and also the rate you will pay.
It is to be noted that your credit score and credit report are two different things. Your credit score is calculated based on the facts provided in your credit report.
Credit Report Vs. Credit Score
Do you know the difference between your credit score and credit report? If not, you are not alone. It is easy to assume that these two are the same. However, if you take a closer look, you may find a difference in how they affect your financial stability.
What Is A Credit Report?
A credit report contains information about your past and present credit agreements, such as loans, credit card accounts, etc. and other lists of enquiries about your credit history. It shows how much you owe the creditors, how long each account has been open and how constantly you make on-time payments. A credit report also lists other public records such as collections or bankruptcy filings.
What Is A Credit Score?
Your credit score is like a grade given to you on your credit report depending upon your credit performance. This three-digit number usually ranges from 300 to 900. There are different credit reporting agencies which assign you credit score. Considering that your credit score will be coming from different agencies, it would differ from agency to agency. A high credit score can indicate a lower risk to the lender and customers with a high credit score will be more likely to qualify for a loan.
What Is Credit History?
Credit history is a record of a consumer's ability to repay debts and demonstrates responsibility in repaying debts. A consumer's credit history includes the following:
Number and types of credit accounts
How long each account has been open
Amount of available credit used
Whether bills are paid on time
Number of recent credit inquiries
It also holds the information regarding whether the consumer has any liens, bankruptcies, judgments or collections. This information is documented on a consumer's credit report.
How Is Credit Score Linked To Loan Approval?
Lenders like banking and non-banking financial institutions rely on credit reports before approving your loan or credit card application. A credit report is evaluated by credit information companies which are also known as credit bureaus. The credit bureaus collect, combine and organize data from their members (consumers and lending institutions) to provide information related to the credit history and creditworthiness of a customer. At the moment, there are 4 major credit bureaus in India. They are TransUnion CIBILTM, Equifax, Experian and CRIF Highmark, which are licensed by the Reserve Bank Of India (RBI).
You may have different credit scores and there are a number of ways to get a credit score. Your credit score can differ depending upon which credit reporting agency is used. Most loan lenders look at scores from all major credit reporting agencies and decide the offer for your score based on the agency.
Errors on your credit report can reduce your credit score substantially, which could mean a higher interest rate and more money spent from your pockets. So, it is important to check your credit report and correct any errors way before you apply for a loan.
Your credit score is only one element of your lender’s decision, but it’s an important one.
Other factors include:
The amount of debt you already have
Credit history with that lender
How much you have in savings
Your total assets
How loans affect your credit scores?
Having a loan and how you manage them is the most important factor in your credit. But credits are complicated and depending on the state of your credit, you may wonder if getting loans could help or hurt your credit scores.
New and existing loans can affect your credit in a number of ways:
They help you raise credit if you successfully make payments on time
They hurt your credit if you make the payments late or default on loans
They reduce your borrowing capacity (which might or might not directly affect your credit scores)
They cause small damage to your credit at first, but they can easily recover if you make payments on time.
Your credit score is all about your past records as a borrower. If you’ve borrowed and repaid loans successfully on time in the past, lenders are likely to believe that you’ll do the same in the future. The more you’ve done this (and the longer you’ve done it), the better.
Taking out a new loan gives you the chance to repay on time and build up your credit. If you have bad credit score or you have never yet known about credit score, it will improve over time with each monthly on-time payment and resolving past negative accounts.
Getting different types of loans also helps your credit score. 10% of your credit score is based on your “credit mix,” which looks at the variety of accounts on your credit report. If all of your loans are credit cards, that might be fine, but your mix is better if you also have an auto loan or a home loan.
Don’t borrow just for the sake of trying to improve your credit score. Borrow wisely, if and when you need to, and use the right loan for the work required.
Of course, those loans don’t do you any good if you pay late or stop making payments. Your credit scores will quickly decrease, and you’ll have a hard time getting new loans.
Ability to Borrow
New loans can affect more than just your credit score; they also reduce your ability to borrow.
Your credit report shows every loan you had and every loan you are currently using, as well as the required monthly payments. When you apply for a new loan, lenders will look at your past and existing monthly obligations and come to a conclusion as to whether or not they think you can afford an additional payment. To do so, they calculate your debt to income ratio, which tells them how much of your monthly income gets disposed of by your monthly payments. The lesser, the better.
You don’t really have to borrow to see your borrowing ability is reduced. If you cosign a loan for somebody, i.e. helping them get approved based on your strong credit and income, that loan shows up on your credit report. You’re 100 percent responsible for repaying the loan if the primary borrower does not repay, so lenders generally count that as a monthly expense (even though you’re not making any payments).
A Slight Dip
New loans normally create a slight dip in your credit score. If you have a strong credit score, that dip is probably short-lived and negligible. But if you have a poor credit score or you’re building credit score for the first time, that dip could cause problems. So, avoid piling up debt before you apply for a "significant" loan like a home loan.
Every time you apply for a new loan, lenders check your credit score. When they do so, an enquiry is initiated, showing that somebody pulled your credit. Inquiries can be a sign that you’re in financially in trouble and you need money, so they pull your score down slightly. One or two inquiries aren’t a big deal, but numerous enquiries can damage your credit score.
If you’re going to shop among lenders - which is wise, and it’s the only way to get the best deal - do all of your shopping within a relatively short time frame. For example, if you’re buying a home and comparing mortgage lenders, complete all of your applications within 30 days or less (the credit scoring models give you a pretty generous window). For auto loans, try to keep everything within two weeks.