Tanisha works as a senior manager in a start-up in Mumbai and has been working for the past seven years. She got married this year and the couple has been able to manage the wedding expenses on their own. However, when it comes to making reservation for their honeymoon, their wedding corpus was exhausted and could not help them plan a honeymoon abroad. Due to this reason, Tanisha and Rakesh (her spouse) decided to take a personal loan to make their dream honeymoon destination of Venice a reality.
After a few months, her husband applied for a car loan from a bank, but to his dismay, the loan was turned down. After this he approached a Non-banking Finance Company, which also rejected his loan stating low credit score as the reason.
Rakesh discussed his problem with a colleague Vaibhav, an ex banker. This is when Vaibhav asked Rakesh to check his credit report and calculate his credit exposure. On doing so, Rakesh realised that his credit exposure due to the joint account was above 45% of his earnings and this had led to a reduction in his credit score.
How did this happen
Credit exposure and utilisation are two important aspects that the borrower should be mindful of. Credit exposure means the total amount of credit that the person has borrowed from the lender. This can be in form of a credit card, personal loan, auto loan etc.
Credit utilisation on the other hand means the total amount of debt the borrower has in relation to the total amount that he/she is earning – this shows the repayment capabilities to the lender. Roughly 30% of your overall credit score is determined by your credit utilisation.
If your credit utilisation is high in comparison to the total amount you have been earning, this shows to the lender that you already have a lot of debt on your plate to oblige. Due to this, with an already exceeding credit utilisation, giving the borrower another loan will become will have a high repayment risk which can even lead to a default.
What happened in the case of Tanisha and Rakesh
In this case where Tanisha and Rakesh took a joint personal loan, credit utilisation played an important role. Tanisha earns an annual salary of Rs 10 lakh, whereas Rakesh earns Rs 4 lakh. The total amount borrowed for their honeymoon was Rs 4.5 lakh. When the total amount borrowed is divided between the two borrowers, it is Rs 2.25 lakh. It gives an overall credit utilisation of 22.5% for Tanisha, which is not high and hence is positive. However, in the case of Rakesh, it is a utilisation of over 56%, which is a really high exposure. When you include credit card to this utilisation, the risk might rise further. Due to this high utilisation and exposure, Rakesh has become a risky borrower to receive further credit.
How can Rakesh can improve his score
A credit score is usually based on six months of payment behaviour on the credit report. In this case, Rakesh should first try and close his personal loan, which will give reduce his credit exposure and utilisation and improve the score. With this he will be able to approach banks again. With his report showing a low credit utilisation, he will have a better chance to borrow the required amount for his auto loan.
Generally, if any person is a co applicant or a guarantor on a friend’s or a relative’s loan, they should monitor their credit report routinely. This is to make sure that the individual who they guarantee or have co-applied with is meeting their repayment obligation on time. If this is not done, the credit score of the guarantor or the co-applicant will also take a hit along with the primary borrower. This can later cause hurdles while applying for credit in future.
The writer is managing director at Experian Credit Bureau