Personal credit versus institutional credit

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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.

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Why is the CIBIL score different for personal loans?

A personal loan is a quick and relatively hassle-free way to secure funds for an unforeseen emergency that requires funds urgently. The best part about personal loans is that the end use is not defined, and you can use the funds to fulfil (almost) anything you had in mind, from a vacation to home renovation to purchasing a new electronic appliance or jewellery. Of course, the usage cannot be such that it violates any laws, for example using the disbursed loan amount for trading on the stock exchange, or gambling or laying bets.

Once you have identified the need for a personal loan, start shopping – look around for the best deals in the market, primarily in terms of interest rates. While the eligibility criteria for a personal loan may differ from lender to lender, one thing that they all have in common is the requirement of a ‘good’ CIBIL score.

What is a CIBIL score?

A three-digit score that indicates an individual’s creditworthiness, the CIBIL score is crucial when it comes to applying for a loan or credit card. When a lender evaluates your loan application, the first piece of information they look at is this score.

Why is a CIBIL score required?

Typically, a score is between 300 and 900, and higher the score, better are your chances of the application being approved. A lower score may indicate that a person relies heavily on credit to make ends meet, and hence a lender may be reluctant to extend fresh credit, as chances of the loan going ‘bad’ or delinquent are higher.

Factors affecting the CIBIL score

Now that we know what a CIBIL score is, let us look at the factors that affect the score:

  • Timely payments on outstanding dues, be it towards an existing loan EMI or credit card

  • Making complete payments on outstanding bills

  • Non-payment or late payment of bills and EMIs

  • Consistently utilising a high credit limit, i.e. either maxing out on the assigned limit or close to it

  • Regularly paying only the minimum due on credit cards

  • Having multiple lines of credit at the same time, especially if unsecured loans or credit cards

While some of these factors affect the score negatively, others can have a positive impact on your score.

CIBIL score and loans

While CIBIL scores are important for any loan application, they assume special significance in the case of personal loans. This is owing to the fact that personal loans are unsecured products, and is therefore more of a credit risk for the lender.

A lender is more likely to approve a loan application for someone with a higher score, which with CIBIL is normally considered to be 700 and above. A ‘good’ score indicates an individual’s responsible behaviour towards credit, and hence it may be worth lending to such a consumer.

CIBIL TransUnion Personal Loan Score

In addition to the CIBIL TransUnion score that is used by banks and other financial institutions when determining whether to approve a loan application (for example, a home or auto loan), there is also the CIBIL TransUnion Personal Loan score that lays special emphasis on any unsecured loans or credit cards that an individual may have in their credit report.

The repayment behaviour on these loans is carefully studied, and a score is arrived based on the same. The score will provide information on the likelihood of the customers becoming 91 days delinquent on a personal loan. This helps a lender make an informed decision, whether to approve the loan application or not.

How to better your CIBIL score

In addition to using credit wisely and making timely payments, check your credit score regularly. This will help you identify any irregularities in your credit report, and these can be rectified once brought to the attention of the credit bureau.

If you still need assistance to improve your score, consider availing of the services of a credit health management company, who will work closely with you to not only improve your score but enhance it over time.

Do keep in mind that for your loan application to go through, being credit healthy is non-negotiable, and the best time to start is now.