Relation between Credit Rating and Debt

Introduction

The relationship between debt and credit rating is complex and crucial in personal finance. Your ability to obtain borrowed money is determined by your credit rating, which acts as a litmus test for your financial reliability. On the other hand, your debt situation impacts this grade. To explain this association, we'll examine how credit scores are determined and how they affect your ability to borrow.

Learn why credit ratings are paramount to lenders, investment banks, and other companies. Examine how your ability to obtain loans, the terms offered, and the charges you will pay are impacted by your credit scores. Find out how your debt loads, repayment habits, and debt-to-income ratios significantly affect your creditworthiness.

A good credit rating comes in handy while applying for a personal or business loan with leading financial institutions. If you're contemplating the same, contact Shriram Finance to avail of personal or business loans at competitive interest rates and favourable loan repayment terms.

Relation between Credit Rating and Debt

A person’s credit rating plays an important role in determining their accessibility to debt. The vital relationship between credit rating and debt emerges from the fact that both rely on each other fundamentally. Let us understand this correlation in detail.   

Some key users of corporate credit ratings include:

• Lenders: To evaluate loan repayment capability before approving loans.
• Investment banks: To determine the pricing of debt instruments and equity shares.
• Debt issuers: To review their creditworthiness before raising capital.
• Investors: To estimate risks and returns before investing in shares/bonds.
• Other businesses: To assess risks before partnerships and transactions.
• Credit ratings directly influence a company's capacity to raise debt. Strong ratings facilitate cheaper and easier credit availability, while poor ratings restrict access.

How does Debt Affect your Credit Score?

Your credit rating influences your capacity to raise debt. Check the below pointers to see how credit ratings impact debt:

• With a high credit rating, you can readily obtain business loans and working capital finance from banks and NBFCs at competitive interest rates and flexible repayment options.
• Lenders perceive entities with excellent credit ratings as low-risk borrowers. You can effortlessly get access to institutional credit if you have high ratings.
• Borrowers with poor or low credit ratings need help to secure loans. Risk-averse lenders often reject their applications.
• Even if a poorly rated borrower gets loan approval, the loan terms are usually stringent. These terms include higher interest charges, collateral demands, and tight repayment schedules. This increases the borrowing cost.
• A sudden downgrade in credit rating can prompt banks to reduce sanctioned loan limits or even recall existing loans prematurely. This severely restricts fundraising options.
• With a drop in credit rating, you may have to rely on alternative sources like private financing, peer-to-peer lending platforms, etc. These options are costlier than institutional credit.
• Lower-rated companies may need to raise funds through debt instruments like corporate bonds and commercial papers, as investors avoid risky instruments.
• Each upgrade in credit rating signifies an improvement in creditworthiness. This allows you to tap more comprehensive and cheaper sources of credit.
• Strong credit ratings allow the re-negotiation of existing debts at lower interest rates, thereby reducing financing costs.
• Your credit rating significantly impacts your overall debt capacity, cost of funds, loan access, credit terms, etc. The better the rating, the higher the debt-raising ability.

A strong credit rating is an important competitive advantage. You must aim to build and sustain it with careful financial management.

How do Credit Scores Contribute to your Debt Potential?

Just as ratings impact debt, the amount of debt you hold also influences your credit rating. Some key factors include:

• High debt levels indicate potential repayment difficulties, especially if loans are mostly unsecured. This leads to a weaker credit rating.
• Low or moderate debt signals comfortable repayment capability, resulting in a higher rating.
• If your loans suddenly increase without matching income/asset growth, your rating can worsen because of higher risk.
• A higher share of equity and secured loans is viewed positively compared to unsecured debt.
• Past repayment history on existing debts significantly impacts upcoming ratings. Timely and consistent payments assist in improving ratings.
• If you fail to pay the complete due and service only the minimum amount, your rating falls over time.
• If rising debt servicing costs consume more operating income, ratings tend to fall.

So, being careful about debt and paying back responsibly instead of careless borrowing helps improve your credit score. They affect each other.

Tips to Maintain Debt and Credit Rating

Here are some tips you can adopt to maintain robust credit ratings:

• Limit overall debt to a manageable level aligned with your growth plans and cash flow projections. Avoid excessive leverage.
• You must maintain a favourable mix of equity and debt. Ensure a higher share of secured loans over unsecured debt.
• Build a long-term track record of disciplined credit behaviour by ensuring timely repayment of all dues.
• Work towards prepaying your loans or making larger repayments whenever possible to reduce interest costs. This shows stability.
• Avoid risks like investing borrowed funds into volatile assets or overexpanding operations using your debt. Focus on profitability.
• You must save cash reserves to manage payment needs, even in bad situations.
• If you have a short-term money problem, speak to your lenders and change loan terms instead of delaying payments.
• Uphold your financial discipline and management integrity even after achieving a high rating. Complacency can erode creditworthiness.

Careful loan handling, paying on time, steady profits, and an increase in income and savings will help you maintain a good credit score.

Debt-to-Income Ratio and Credit Rating

Similar to a financial balance check is the debt-to-income ratio (DTI). It displays the percentage of your monthly income used to pay off debt. A lower DTI is preferable since it indicates you will have more money after paying off your obligations.

Your credit rating serves as a report card for your financial behaviour. It's a rating that lets lenders know if you're reliable with money management and timely bill payment. Higher scores are preferable as they demonstrate your financial responsibility and make it simpler to obtain loans or credit cards with reduced interest rates. So, to have a stable financial life, strive for a low DTI and a strong credit rating.

How do Credit Ratings Influence the Cost of Debt?

Your credit rating has a significant impact on the cost of debt. Check out the following aspects for better understanding:

• Lenders charge a lower interest rate and relaxed repayment terms for borrowers with excellent credit ratings since they are considered low-risk.
• Lenders will charge you higher interest rates to compensate for the perceived higher risk and probable defaults if you have poor credit ratings
• Business loans for companies with robust credit ratings often waive or lower processing fees, prepayment penalties, and other charges. This will reduce the effective cost of borrowing.
• With strong credit ratings, you can raise funds through low-cost debt instruments like commercial paper, bonds etc., rather than expensive business loans.
• When you have a higher credit rating, you can negotiate with multiple lenders and debt investors for better rates due to your enhanced creditworthiness. This increased competition reduces borrowing costs.
• After a credit rating upgrade, you can rework existing debt contracts to get lower interest rates from lenders, saving significant interest expenses.
• If you have an excellent credit rating, you may get pre-approved loan offers from lenders at acceptable rates, providing cost-effective options for future fundraising.
• Good ratings allow access to a wider range of debt sources - banks, NBFCs, private capital, public issues, etc. This diversification leads to lower costs.
• Even a top rating upgrade can dramatically reduce the interest rate offered to a corporate borrower by at least 50 to 100 basis points, lowering debt costs.
• Defaults and downgrades in credit ratings can instantly shoot up your borrowing costs as lenders classify it as high risk.

By proactively building and sustaining a high credit rating, you can substantially reduce capital costs and improve profitability over the long term.

How To Track Your Credit Score and Report?

You must periodically track your credit score and reports. Below are some key aspects that will guide you on ways to check your credit score and report:

• Get your credit report online instantly through the Credit Information Bureau (India) Limited (CIBIL™), Experian, and other credit bureaus by providing your PAN details and payment.
• The report provides your current credit score, loans and credit accounts summary, repayment history, lenders' inquiries, defaults, etc.
• You should review the report carefully to identify errors like loan or credit card details that you do not recognise or any wrong repayment dates.
• You must raise disputes for any errors found by contacting the credit bureau. Rectifying errors can improve your credit score.
• By sharing your KYC (know your customer) details, you can access your credit score directly through fintech apps like MoneyView, CRED, BankBazaar, etc.
• You should check your credit report quarterly and your credit score monthly to monitor your credit health.
• If your credit score declines, take prompt actions like reducing credit utilisation and avoiding further defaults, etc.

Reviewing your credit profile provides an opportunity to protect it and take corrective actions as required.

Conclusion

Your creditworthiness is assessed through your credit rating and impacts the amount of debt that you can raise along with the cost of that debt. While ratings affect debt capacity, your existing debts and leverage also affect the upcoming credit rating. This two-way correlation necessitates financial discipline to sustain strong ratings.

For guidance on improving your credit rating or debt management, trusted financial services providers like Shriram Finance offer expert advice tailored to your credit profile needs. Reach out now and never lag in taking your financial game to another level.