How banks check if you are a bad borrower

The irony of the situation is that every borrower seeks a loan with lowest interest rate whereas every lender wants to lend at the highest interest rate. Risk perception is different in case of different borrowers and ideally is determined from their credit history. Till now banks had only their own experiences with customers to fall back on for their credit risk assessment. But this is changing now with the entry of agencies -- chief amongst them being the Credit Information Bureau of India, CIBIL -- that assess the creditworthiness of people.

Need for credit score?

Credit score provides a speedy and objective way to assess risk. This way, financial institutions, lenders and banks can analyse a loan or a credit card application in a speedy manner without having to make complex calculations each time.

Instead they have scales that ponder the applicant's standing with several predefined loan or card models and they define the product's variables by matching the rank to the models. Hence, they can easily state in a matter of minutes how much you can borrow, for how long and at what rate, etc.

Credit score comprises of factors like payment history (including any late payments or missed payments that will affect your score negatively), credit card balances (that will be taken into account when the loan amount is determined), bank accounts (including savings and checking accounts) and any other form of credit including all outstanding personal loans, mortgage loans, store cards, etc.

Credit score is simply a number; it is not standardised and each lender, financial institution, risk analyst, etc. can have their own. This number reflects a level of risk that defines whether it is advisable or not to lend money to someone and thus, how much interest should one charge in order to compensate for that risk.

The number is created based on inputs from the credit report. Entries from past will be pondered and assigned a value, the summing or deductions of those points will define the credit score.

Even though there is no standardised model of scoring, usually there are many similarities between the models of lenders that deal with the same type of loans, a mortgage lender and a car lender will probably use different scoring models because the risks associated with these two transactions are significantly different.

Your credit score will fluctuate according to the inputs on your debt history that are reflected in the report. Each timely payment will be recorded as a positive input, while late payments or missed payments will impact negatively on the records thus reducing the score count.

Though each lender will calculate the grade in different ways the source of information that they will use is the same and thus, one should manage to keep credit report clean. It helps to keep your grade clean and keep it in a good stance regardless of the lender.

Some banks give 100 per cent finance on car loans. The truth is that this kind of finance is only available to people with perfect credit score. Most people with average to low credit score will have to pay higher interest rates.

Now lending banks can source your credit score from CIBIL, to supplement the information you furnish in your loan application.

Say if you default on a loan from one bank, it will bring down the credit score, which any other bank that you go to will also be privy to. It will determine not only whether you can get a loan, but also the rate of interest you pay on it. So it is important to learn how to keep the credit score high.

Nevertheless, always watch credit score closely and avoid damaging credit history with late or missing payments, too many outstanding loans and too many loan requests. Credit score is the indication of financial health and even when sometimes it can't get a better credit score, if it drops too much the application could be declined.