Credit Score Vs Credit Risk
The difference between credit score and credit risk assessment can be confusing. The terms looks similar to each other and sounds interchangeable. Actually, both provide a measure of a borrower’s credibility but, there are certainly differences on how they operate, how they are calculated and their impact on interest rates.
A credit score is a numerical score that evaluates a person’s creditworthiness based on their credit history. Lenders often use this number to evaluate the probability of debt repayment on the consumer’s part. It ranges from 300 to 850, and logically the higher is someone’s score, the higher is his/her financial trustworthiness.
Though there are many credit scoring models in use, the most commonly used by financial institutions in India is the CIBIL score, which ranges from 300 to 900.
Lender’s check the credit score for their decision on the loan approval. Those with credit scores below 700, are considered subprime borrowers. Lower the credit score higher the interest as the borrower with low credit score is seen as a risky. Whereas, a borrower with a good credit score will be in a position to negotiate a lower interest rate. when borrowing from personal loan institutions. What are the factors that impact your credit score ? Credit scores calculations are based on a variety of factors:
- Credit History, which accounts for 30% of CIBIL score calculations.
- Credit Utilisation, accounting for 25%.
- Credit Duration, accounting for 25%.
- Miscellaneous factors like how many applications have been made in the past account for the rest 20%.
A point to remember is having a good credit score does not automatically mean that a loan application will be approved, but it increases your chances significantly.
Credit risk assessment involves estimating the probability of loss resulting from a borrower’s failure to repay a loan or debt. Traditionally, it refers to the risk that the lender may not be able to receive the principal and interest.Credit risk assessments are carried out on the borrower’s overall ability to repay a loan according to its original terms. To assess credit risk, lenders often look at the 5 Cs:
- Credit history,
- Capacity to repay,
- Capital,
- The loan’s conditions and
- Associated collateral.
Credit risk assessments have replaced credit scores as a way of checking a consumer’s trustworthiness, with many financial institutions establishing separate departments for assessing credit risks. They are a key factor for large loans provided by banks, financial institutions and NBFCs, such as mortgages, credit card bills etc. CRA has a significant impact on the interest rates, as higher the credit risk perceived, higher will be the interest rates for the capital. Creditors/banks can also decline loan applications if the risks are too high. In a nutshell, better credit ratings for borrowers attract lower interest rates.CRISIL (Credit Rating Information Services of India Limited) and ICRA Limited are two of the most famous credit rating agencies in India.
Credit scores and credit risk assessment are important factors for a borrower. They are impacted by past credit history, but financial institutions are beginning to lean towards credit risk assessments when dealing with loan applications. CRAs are more comprehensive and provide a better overall idea about a borrower.
18-09-2020