Personal credit versus institutional credit


Credit refers to an agreement wherein a borrower receives something of value (for example goods or a service) with the understanding that the lender will be repaid in the future. When a lender extends the facility, the borrower typically repays the loan with interest.

What is personal credit?

Simply put, personal credit is the type of credit facility extended to an individual. This includes both loans and credit cards. Approval of a personal credit facility to a large extent depends upon the data captured in your CIBIL report and the CIBIL score which is an outcome of complex algorithms based on the data.

Loans provide the option whereby you can borrow money towards purchase of say a house, or a car. There are various types of loans available to an individual, ranging from secured to unsecured loans. Let us take a look at some of these types.

Secured loans: This type of loan requires collateral to be provided against which the loan will be provided by the lender. Mortgages (or home loans), auto loans are the most availed of loans in this category. A security is created against the collateral offered, which is then hypotheticated to the lender until such time that the loan is repaid in full. Typically, the loan is paid off in monthly installments over a period of time.

Unsecured loans: A credit card would be a prime example of unsecured lending. Here, a lender extends credit to an individual without requesting for collateral. The amount due (that is the amount spent) on the credit card has to be repaid at the end of each billing cycle. If you choose to roll over your payment, the card issuer levies an interest charge on the outstanding amount, and hence it is prudent to make card payments in a timely manner. Therefore, it is very important to compare credit card before applying.

Credit cards are of various types ranging from charge cards and globally, store cards.

Another popular type of unsecured loan is a personal loan. Here, the lender extends credit for personal use, ranging from home renovation to going on your dream vacation.

Overdrafts constitute another type of loan, wherein basis a facility provided by your bank, you can withdraw money even once your account balance has gone down to zero. In this option, a limit is set depending on your account history and requirement.

Overdrafts come with an interest rate that can be fairly high and are best used for a short-term purpose.

Loans can also be obtained against valuables such as gold, or assets such as securities (or stocks). These loans are also to be repaid within a specific period of time and come with a rate of interest.

What is institutional credit?

In addition to loans for individuals, lenders also provide loans and overdraft facilities to companies, typically for business expansion. For example, a transport company may avail of a loan in order to increase their fleet of vehicles so that they can cater to a larger geographical reach.

The access to capital becomes critical for an organisation to function, across all aspects of the business.

Long-term loans are among the most popular type of loans made available by lenders to institutions. These serve varied purposes – from expansion of business, acquisition and fulfilling working capital requirements.

These loans are normally at a lower interest rate compared to short term loans and need to be repaid on a monthly basis. Lenders prefer to extend this type of credit to seasoned businesses.

Short-term loans, like the name suggests, need to be repaid in full at the end of the loan tenure. These are used to raise money for short term needs such as purchases to increase inventory.

Credit lines are made available to businesses when they require funds on a need-only basis. For example, working capital finance that a cargo company avails of, to buy a number of trucks.

Given the nature of the product however, these can come at fairly high interest rates and most institutions tend to use them to bridge short-term funding requirements.

The bottom line

Irrespective whether you are an individual looking at credit or an institution, you need to be credit healthy for a lender to extend you the facility. Therefore, it is imperative to maintain a clean or good repayment track record on any existing debt, and make timely payments.

If your credit health needs a boost, consider availing of the services of a credit health management company to understand where you stand, and how you can get stronger.


Don’t undermine your old credit card for a good CIBIL score

Building a good CIBIL score requires diligence and patience and is not something that can be achieved overnight. Even if you are promised quick-fix methods to build your score, beware – they are the ones most likely to backfire. Over time however, you can work towards improving your credit score, by focusing on your credit history.

Credit cards are one such product that if used judiciously, can help you not only build but also enhance credit score over a period of time.

What is a CIBIL score?

It is a credit score generated by CIBIL, India’s oldest credit bureau. Owing to the first mover advantage, credit scores are very often referred to as CIBIL scores colloquially.

The first step

Your immediate plan of action should include requesting for a copy of your credit report, so that you know where you stand, and where you want to be. Check the report for errors and if you do spot any, have them rectified by contacting the concerned credit bureau. Keep a keen eye out for any payment-related inaccuracies such as delayed or skipped payments.

How will your old credit card help?

If you have been using a credit card for a fairly long period of time, don’t discontinue the card. Making timely payments on cards can generally help improve your score, as it shows a lender that you are able to use credit responsibly. Of course, this only works when you have no delayed or skipped payments, so be very careful as to how you utilise your credit cards. Someone with no credit card usage on their records at all is more likely to be perceived as a higher risk as compared to someone with responsible usage patterns.

Further, you need to use the card to continuously increase credit score, but make sure you don’t max the credit limit on your card. A good rule of thumb is to stay well within the amount assigned to you, the ideal being up to 30% of usage. Consider this: use as much as you can comfortably repay when the bill comes in. If you find it tricky to keep tabs, use your credit card as a debit card – remember that the money in your savings account will go towards card bill payment. In the meantime, rack up reward points on your card that you can then redeem at a later date. This will help boost your credit score, and at the same time you would have stayed well within your means. Credit cards are ultimately not free – while they do offer you the convenience and ease of use, never forget that the dues have to be paid, as it is nothing but a loan.

Also, it is likely that an older credit card has over time been assigned increased credit limits. If you abruptly close your card, the credit utilisation ratio on your remaining cards will go up, with the now reduced combined limit across cards. This can drastically affect your score, as it works as a red flag to lenders. If you really do need to close out an account, consider closing a newer one or maybe one with annual fees instead. You could also try to curb your spending, but retain the old card instead.

The length of credit history is an important parameter when it comes to credit reports. Hence, a card with some vintage, or a ‘good’ old card can go a long way in boosting your score. The older your accounts, the more responsible you seem to a lender and you are rewarded accordingly.

The bottom line

Ultimately, the decision of whether to continue with an old card account or not is entirely your decision. But do keep in mind that undermining such card accounts can be more damaging, and it might just be worth your while to keep them live.


What is better for CIBIL score- Credit Cards or Personal loans?

Credit cards and personal loans are the two most popular types of unsecured debts available out there in the market. While a personal loan is a good way to finance lump sum for your monetary needs like buying a vacation or your favourite gadgets, credit card is more of an ongoing business of taking credit every month and paying it back before due date. It is important to note that both have a due date or EMI / bill payment which should not be missed.

Personal loans are considered the most expensive forms of loans, and yet their interest rates are lower than those of credit cards. The interest rates of personal loans become applicable right from day one, as soon as money is disbursed. It is a short term loan that requires minimum documentation, and once the money is disbursed no-one questions how the borrower has spent it. Thus, a personal loan is a good way to improve CIBIL score if it is low. A borrower can take loan and ensure that he/she pays all the EMIs on time and closes the loan as per agreement. This will create a positive effect on the credit report. The disadvantage of personal loan is that, if the borrower is not able to pay EMI as per schedule it immediately reports as a default in the CIBIL report. This has grave negative consequences. Also in case the borrower is not able to pay the personal loan in full, and goes for a loan settlement, this reduces the credit score. Thus, while a personal loan is a great instrument to get quick finance, it is a two-edged sword that can make or break your credit history.

A credit card on the other hand is an ongoing credit instrument, the biggest benefit being that if you plan your expenses properly according to your billing cycle, you have almost 30-40 days of interest free period wherein to make the payment and pay only the amount that you actually spent. Many credit cards today also offer the facility to convert any big purchase in monthly EMIs for a small charge. Thus it is a suitable credit instrument for person with monthly source of income. All credit cards offer a facility of minimum payment due. If you pay the minimum amount due, it does not show as a default or missed payment in the credit history. But this is actually a trap, because by paying only the minimum due amount, you end up starting interest levy on the outstanding amount immediately. This interest is cumulated on daily basis and can be very high (as high as 35-40%). Thus in the next bill you receive an exorbitant bill amount which may be further beyond your capacity to pay.

Thus, both personal loan and credit card can affect your CIBIL report in positive and negative ways. It depends on the financial needs and financial capacity of individual borrower to take what suits them.