Credit score and credit history is one of the most important criteria for availing loans in financial system. A credit score is a part of a credit report that tells about borrowing behavior and repayment patterns of the applicant. It records all the past borrowing from banking system. It helps the lender to determine the credit worthiness of borrower. The credit reports are utilised by the lender to make decisions regarding extending the credit line to the borrower. A good credit score indicates a good repayment capacity whereas bad score reflects poor financial management. To understand in details let’s take a brief look into credit score.
What is a credit score?
A credit score is a numerical value assigned by credit information companies to individuals and non individual. It forms a benchmark for financial institutions for making multiple financial decisions. A good credit score enables fast credit at low rate of interests whereas bad credit score can be pose difficulties for getting loans. A bad credit score can result in higher rate of interests if at all the credit facility is extended. To ensure a good credit worthiness, one should have a good credit score. Along with credit scores, the history of the borrowing is also important for making financial decisions for the lender.
What is credit history?
When a financial institute draws a credit report from credit information companies (CIC), it includes the credit score and history of borrowings. As credit score may help to determine the risk grading of the customer, the credit history determines the past behavior for repayments by the borrower. If the borrowing history have defaults, write offs or settlements banks may reject the proposals. These loan accounts can be classified in terms of asset classification as standard, sub standard, doubtful, loss etc. It all depends on repayment behavior of the applicants towards a specific loan.
What is Risk grading?
Risk grading is classification of customer based on the credit score obtained in the credit reports. It can vary with financial institutes as they may consider other factors to determine risk grading of the customer but generally credit score is an important criteria to determine the risk grading.
- Low risk grade: – A good credit score above 750 is considered low risk grade customers. These are considered the safest borrowers, provided with good repayment history. These borrowers may get the best rate of interest for the loans.
- Normal risk grade: – A credit score that lies between 700-749 is considered normal risk gradings. A borrower with no credit history is also considered normal risk grade. It is considered credit worthy to extend finance. These borrowers may or may not have irregularities in there past finances.
- Moderate risk grade: – A Moderate risk grade usually hovers between 650-699. This risk grading is acceptable for extending credit facility. Though credit history also plays important role for making decision. Moderate risk grade can result in higher rate of interest compared to normal and low risk grades.
- High risk grade: – High risk prospects are those whose scores are below 650 credit score. A high risk grade prospect is difficult to finance for FIs. Usually financial institutes avoid high risk proposals for financing. Though its difficult, if provided with proper reasoning high risk prospects can be considered for financing.
What are the asset classification in a credit report?
A loan is a liability for the borrower but on the same time its an asset for the financial institute. It is classified in multiple manners. One of these is as per the performance of the loan account. It is either performing or non performing asset. If a loan account has been paid regularly of irregularly but the overdue period does not cross 90 days it is classified as performing assets, this is also called a standard asset.
If a loan account has not been in overdue for 90 days or more it is classified as non performing asset (NPA). An NPA account is also called substandard loan account. Once a loan account has been classified as an non performing asset (NPA) the financial institute will have multiple options to take further steps like legal proceedings, seize of asset created through credit, seize of other assets on the name of borrowers, Additional rate of interests, additional charges, etc.
The credit reports classifies the loan account is more specified manners. This classification provides more details about the loan accounts. It is classified in
- 00 – If loan account is showing 00 in the credit report means the repayment of the loan has been on time for the said loan account and there is no overdue for a specific time of repayment from the borrower. If the loan account shows regular 00, it indicates good credit worthiness of the borrower and it helps to improve credit score for the borrowers.
- Numbers between 1-29: – it is considered as delays in repayments for the specified loans for specified periods. These are called special mentioned accounts 0 (SMA 0). It means the borrower has not been able to repay in the short span. It can have a small to moderate negative impact on credit score. An SMA0 account can be due to genuine issues or some mistakes, it may have little to no effect for availing loans.
- Numbers between 30-59:- If a loan account has not been paid for more than 30 days up to 59 days, it is called special mentioned accounts 1 (SMA1). These are a more serious forms of defaults compared to SMA0. This may have severe negative impact on the credit score of the borrower. A loan account in SMA 1 means the borrower has to repay at least two EMIs which is again can be difficult for the borrower. Presence of SMA1 in credit history pose moderate to little negative impact on credit worthiness of the borrower.
- Numbers between 60-89: – If borrower has not been able to pay the installments of the loan for 60 to 89 days from the due date it is considered SMA2. These type of asset classes are difficult to recover as the overdue amount has been higher along with penalty. Presence of SMA2 in credit history bears server negative impact on the prospects of availing new loans for the borrower.
- Numbers more than 90 or substandard: – Once a loan has not been repaid for 90 or more days from its due date it is considered to be a substandard loan account. These types of accounts are also called non performing assets (NPA). For FIs, a loan account lying into NPA category can be difficult to deal with. FIs may start a legal proceeding against borrower, they can charge hefty fees for the borrowers. For such accounts, lenders need to have higher provisioning in their balance sheets. It becomes difficult for borrowers to avail loan facility from banks when credit history shows presence of NPA.
- DBT: – DBT in a credit history indicates doubtful loans for the lenders. A DBT or doubtful loans are those which are considered highly unlikely for repayment. A DBT without proper justification form the borrowers becomes reason for loan proposal rejection.
- LSS: – LSS in a credit history report is loss loan assets for the laundered. These are the loans are considered loss to the lenders. These can be further considered for write offs in balance sheets of the FIs. A LSS requires maximum provisioning for the lenders in the balance sheets. These are most suitable for one time settlement (OTS).
- OTS is scheme offered by lenders where borrower and lenders can agree to fractional amount of the liability and settle the loan account once for all. This still shows on the credit history and will pose a threat to future prospects of availing new loans. A loan account which has turned doubtful or loss for the lender can be considered for OTS. Usually unsecured loan accounts are offered with OTS option. Where as in secured loans, the underlying asset is sold/auctioned to recover the due, charges, penalties etc.
Conclusion
Credit score and credit history plays an important role in financial world. It’s your janmkundali in the world of finance. It records all your previous credit related transaction that helps to determine repayment history, financial decipline, availed loans, quality of credit and ultimately tells about credit worthiness. A good credit score and credit history helps to get better rate of interest with favourable terms whereas bad report can lead to rejection. One should always be careful regarding repayments because every transaction is being recorded in your credit history.