Lenders, whether it is a bank or a non-banking finance company (NBFC), lend money hoping that it would be returned in full along with interest payments and any other charges associated with advancing the debt.
They do have a fall-back option by invoking the pledge that allows them to sell the asset furnished as a security, but this is possible only in the case of a loan backed with a collateral. Such loans are advanced in lieu of a security where the borrower pledges something of value in favour of the lender. The lender ensures the value of the collateral is higher than the loan, so as to have a reasonable comfort that in case the borrower defaults, the value of the security would be enough to recover the money.
However, things are quite different for an unsecured loan such as a personal loan. In this case, the loan is not secured with a collateral and is entirely on the basis of the risk assessment by the lender of the person availing the money. This is done by scanning the credit history of the borrower.
The credit history does not provide a guaranteed risk mitigation tool as one may change their behaviour in the future due to one or more reasons, including change in their ability to pay back. But it does give a signal of how creditworthy is a borrower.
One’s credit history is represented by their credit or CIBIL score. The number is generated by various agencies but has become synonymous now with the first agency to do so in India, CIBIL (now known as TransUnion CIBIL).
It is a three-digit number that varies between 300 and 900. The higher the number, the more creditworthy is the person. The lower the number, the poorer is his or her credit history.
The score is generated based on current or old loans and how the borrower has serviced those debt, be it by paying the equated monthly instalments (EMIs) on time or the total quantum of outstanding loans as on date as it shows how much the person may be left with to service other debt, if any.
It also takes into account the credit cards in use by the borrower as plastic money after-all is also another form of debt in effect. If one has been paying the minimum amount due every month for using the card, it is considered enough for a good credit history. However, one should take care not to max out the upper limit of the credit card or keep running large outstanding on the card as that negatively impacts the credit score.
Importance of CIBIL score for personal loan
Since a personal loan is a form of an unsecured loan, lenders need to rely on other tools to evaluate a loan application. They do so by checking the credit history or credit score of the loan applicant.
The thumb rule for all lenders is to use 750 as a threshold to place a borrower as creditworthy.
To be sure, a lower score does not make one ineligible from availing a personal loan. For instance, NBFCs are more flexible with their lending practices and are open to advancing money to those with a lower score, albeit with a higher interest rate.
Banks do, however, follow the score more strictly. There is a high chance of a bank rejecting a personal loan application if the score is below 700-750 level. This is even if the borrower’s income is much more than what’s required to service the EMIs.
Notably, a low score runs the risk of personal loan application being rejected even though it is not the only factor on which a lender bases its decision to sanction the money.
There are several benefits of a high CIBIL score for personal loans.
• Swift approval
• Lower interest rate
• Flexible payment terms
• Eligibility for a higher sum
As a result, borrowers need to focus on pushing their CIBIL scores to a higher level to gain from the benefits of better creditworthiness before thinking of availing a personal loan.
A personal loan is a form of unsecured loan where the lender does not have a recourse to invoking the pledged collateral to recover the money if there is a default in payment by the borrower. Because of this, they anchor their decision to approve or decline a loan application on the credit score of the applicant.
A high CIBIL score all but guarantees that the lender will sanction the money. The importance of a high score is underlined by the other benefits such as quick approval of the application, lower interest rate being charged by the lender, much more flexible repayment terms and eligibility for a higher sum.
Prominent NBFCs like IIFL Finance offer personal loans of as much as Rs 5 lakh for up to 42 months at low interest rates without the need for any collateral. IIFL Finance provides personal loans via a quick digital process where the money is disbursed to the account of the borrower within 24 hours.
For more information, visit www.iifl.com
Download Money9 App for the latest updates on Personal Finance.