Your credit score plays a crucial role when you apply for a personal loan. It gives financial institutions an idea of your creditworthiness and repayment capacity. If you have a low credit score, your chances of getting a personal loan approved become low.
On that note, let's understand how a credit score on personal loan impacts your eligibility and the steps you can take to improve your score.
What is a Credit Score?
A credit score is a three-digit number between 300 and 900 that represents your creditworthiness. It is calculated based on your credit history, payment patterns, total debts, credit utilisation ratio, and other factors. A higher credit score indicates that you are more likely to repay debts on time.
Financial institutions, banks and NBFCs refer to your credit score when reviewing your personal loan application. They use it to determine the risk involved in lending money to you.
How is a Credit Score Calculated?
The most widely used credit score model in India is the CIBIL™ (Credit Information Bureau of India) score. It is calculated based on these 5 parameters:
- Payment History (35% weightage): Your history of repaying past debts and bills on time. Late or missed payments can lower your score.
- Credit Utilisation Ratio (30% weightage): The ratio of your total credit card limits versus the total balances across cards. Higher utilisation hurts your score.
- Credit Mix (10% weightage): The variety of loans and credit cards you have. A good mix improves the score.
- New Credit Applications (10% weightage): Frequency of new credit applications. Too many in a short span implies credit hunger.
- Credit History Length (15% weightage): The number of years you have managed credit. A longer history improves the score.
Disclaimer: The weightage of factors in credit score calculation may vary slightly across different credit scoring models. The above is a general guideline. Please check with your respective bank or financial institution for their exact scoring model.
How Does Credit Score Impact Personal Loan Application?
When you apply for a personal loan, the bank or NBFC will check your credit report and score. Here is how it affects your loan eligibility:
- Higher Chances of Loan Approval: If your credit score is over 750*, financial institutions perceive you as a low-risk applicant and easily approve your loan application. However, the exact credit score that determines your credit health differs with banks and NBFCs.
- Faster Processing: Good credit score applicants can get quicker loan disbursal as minimal documentation is required.
- Lower Interest Rates: Top NBFCs offer lower interest rates starting from 12%* to applicants with excellent credit scores. This saves money.
- Higher Loan Amount Eligibility: Applicants with a 750*+ credit score can be approved for 80-100% of the requested loan amount.
- Longer Repayment Tenure: If you have an excellent score, you may get a longer repayment tenure of 5-7 years for personal loans.
Challenges with Low Credit Scores
Though not impossible, yet getting a personal loan approved can become challenging if your credit score is below 650*. Here are the implications:
- Loan Rejection Risk: Many financial institutions may reject personal loan applications for poor credit scores below 600*. However, with reputed NBFCs like Shriram Finance, the chances of loan approval even with low credit scores are higher.
- Higher Interest Rates: Banks and NBFCs may offer loans but at a higher interest rate of 18-22% to offset the high risk.
- Lower Loan Amount: You may only get 50-60% of the requested personal loan amount approved.
- Shorter Loan Tenure: Loan tenure may be restricted to 1-3 years compared to 5 years for high scorers.
- Higher Processing Fees: Financial institutions charge higher processing fees on personal loans for low credit scores.
- Collateral or Guarantor Needed: Some banks and NBFCs ask for collateral or guarantor for applicants with low credit scores below 650*.
Steps to Improve Your Credit Score
You can take several steps to boost your credit score before applying for a personal loan:
- Make all your credit card and loan EMI payments on time, every time. Even one single late payment can negatively impact your credit score.
- Keep your credit utilisation ratio low, ideally under 30%. Using more than 50% of your total credit limit will diminish your credit score.
- Avoid applying for multiple new loans or credit cards within a short period. Numerous credit inquiries in quick succession denote credit hunger.
- Initially, take secured loans and credit cards to build a healthy credit mix. Gradually move towards unsecured loans over time.
- Retain old unused credit cards by making small transactions. Having a long credit history strengthens your credit score.
- Review your credit report annually and get any errors fixed. Inaccurate information depicts your credit wrongly.
- Add loan co-applicants or guarantors if your individual credit score is low. It can improve your chances of loan approval.
Summing Up
A strong credit score helps you get quick approval on a personal loan with better terms. If your score is low, take steps immediately to boost it above 700*. This will make financial institutions view you as a worthwhile borrower for an unsecured loan. Manage your credit responsibly to enjoy the benefits of easy loan approval down the line.
FAQs Personal Loan Credit Score
1. How can I get a personal loan if I have a low CIBIL™ score?
You can still get approved for a personal loan even with a low credit score, but you may need to accept higher interest rates or lower loan amounts. Opting for a secured loan by collateralising an asset is also an option. Adding a co-applicant with a good credit score also helps. Applying for a personal loan at top NBFCs may also increase your chances of loan approval.
2. What is the minimum CIBIL™ score required for a personal loan?
Most banks and NBFCs require a minimum CIBIL™ score between 650-750* to approve a personal loan. Some may approve if the score is over 600* based on income eligibility. However, you may get a lower loan amount or pay higher interest rates.
3. Does having a zero or no credit history affect personal loan eligibility?
Yes, having no prior credit history will make financial institutions perceive you as a risky borrower. Opening a credit card and taking some loans to build a credit history will help improve your chances of loan approval later.
4. How long does it take to improve my CIBIL™ score?
If you make timely repayments and use credit judiciously, it can take 6-12 months to substantially improve your credit score. Adopting long-term credit management habits helps build a strong score over time.
5. What factors bring down my CIBIL™ score?
Frequent loan applications, high credit utilization, late repayments, loan defaults, settlements, and written-off loans bring down your CIBIL™ score. Maintaining credit discipline helps avoid these negatives.
6. How can I check my credit score for free?
You can check your credit report and score for free once a year by visiting the CIBIL™ website and providing identity details. Shriram Finance also offers a free credit score-checking facility on the official app and website.
