Know How CIBIL Score is Calculated and the Factors that Affect It

In India, four credit information agencies or credit rating agencies have been authorized by the Reserve Bank of India to collect information on borrowers’ attitudes towards credit. These are Experian, Equifax, CRIF Highmark and TransUnion CIBIL. The credit rating given by TransUnion CIBIL is known as the CIBIL score and most lenders rely on TransUnion CIBIL to help them verify whether a borrower is creditworthy.  

How is CIBIL Score Calculated? 

The credit score or CIBIL score is a numerical representation of one’s creditworthiness and repayment capacity. It is a three-digit number ranging between 300 and 900 that tells a lender the risk involved for them in lending money to the borrower. How is credit score calculated? Credit rating agencies calculate an individual’s CIBIL score based on all the information provided in an individual’s credit report. Before we get to the details of CIBIL score calculations, let us understand the various CIBIL score ranges and the impact they have on a borrower’s ability to borrow credit.  

Factors That Affect CIBIL Score Calculations

Four different credit information bureaus in India are authorized by the Reserve Bank of India to assign credit scores to borrowers. Every credit information bureau uses a different CIBIL score calculation formula. However, since an individual’s credit score primarily depends on how they handle credit, the elements that affect a borrower’s credit score stay the same. Let us look at the elements of CIBIL score.

How the Borrower Handles Debt

All credit information agencies assign credit scores to borrowers based on how they have handled debt in the past. A borrower’s credit history, i.e. their track record of whether they have always paid EMIs and cleared credit card bills on time, the number of loans they have taken and successfully repaid, the number of times they have been rejected by lenders, etc., gives credit information agencies an idea about how the borrower handles debt. The component that influences credit score calculations is credit history, which accounts for 35% of a borrower's credit score. 

What is the Credit Mix They Are Having?

Loans are of two types: secured and unsecured. Secured loans are those that are backed by collateral. In the case of secured loans, there is zero to no risk involved for the lender in lending money to the borrower. Thus, lenders sanction secured loans at low-interest rates. Home loans and loans against property are examples of secured loans. Unsecured loans, on the other hand, are not backed by any collateral, and therefore, these loans carry a higher risk for the lender. Lenders like those borrowers who have handled a mix of both types of credit, as it assures a lender of the borrower’s ability to handle both secured and unsecured loans. 

Also Read: Credit Mix: Different Types of Credit that Boost Your Credit Score

Credit Exposure

Most borrowers understand the concept of credit exposure in the form of credit utilization rate or ratio. The credit utilization ratio is the ratio of credit used by a borrower to the credit available to them. Borrowers must never exhaust their credit limit as lenders see this as irresponsible behaviour towards credit. Maintaining a good CIBIL score requires borrowers to maintain a credit utilization ratio of 30% or less. Borrowers must also make it a point to clear their entire credit card bills and not just pay the minimum due as this too reduces one’s credit rating.

Other Factors

Apart from the factors mentioned above, there are some other factors too that affect CIBIL score calculations. For instance, while calculating CIBIL scores, credit information agencies also look at the hard enquiries under a borrower’s name. Every time a borrower applies for a loan, the lender to whom they have applied approaches a credit rating agency to enquire about the borrower. Enquiries that lenders make are known as hard enquiries. Too many hard enquiries may portray a borrower as being credit-hungry and hamper their credit rating. This is why borrowers should apply for a loan only when absolutely necessary.  

Similarly, credit rating agencies also look at what percentage of a borrower’s income is going towards covering the debt. This is known as debt-to-income ratio and for a good CIBIL score, a borrower should keep their debt-to-income ratio under 40%. The length of the credit history is another factor that affects a borrower’s CIBIL score. The longer a borrower’s credit history, the better their CIBIL score. 

Final Words

The CIBIL score is a key element that defines your ability to borrow money as well as the terms and conditions on which you will get this money. Building a good CIBIL score takes time. A good CIBIL score is also important as it helps borrowers avail of credit on beneficial terms and conditions, such as a low-interest rate, longer repayment tenor, etc. A bad CIBIL score, on the other hand, makes it difficult for borrowers to get approved for credit. The good thing is that the CIBIL score is not absolute. Borrowers can improve their CIBIL score by practising healthy financial habits.  

Also Read: How to Improve your CIBIL Score above 800