Effective October 1, banks are allowed to charge a credit-risk premium over external benchmarks for calculating the effective interest rate on loans. This makes the credit score of borrowers an important factor in determining the interest rates.
Moneycontrol’s Hiral Thanawala spoke to Sathya Kalyanasundaram, Country Head and Managing Director, Experian India. Sathya talks about the importance of maintaining a good credit score and ways to improve it. He stresses that every single financial action of the consumer impacts the credit score either in a positive or negative manner. Edited excerpts.
Q: Banks are now allowed to charge a credit-risk premium over effective interest rates on loans. What are the factors consumers must keep in mind to maintain a good credit score?
A: With rising demand for credit from consumers, it is a good sign that banks are now linking interest rates to borrowers’ credit behaviour and performance. Now, every single financial action of the consumer impacts the credit score either in a positive or negative manner. The first step that a consumer should take is to understand her credit score, along with the credit report and review them in detail at least once in a year. In the credit report, check for loans linked to your name, number of credit cards, liabilities, etc. Then rectify your credit report with the credit information company by providing the right data if there is any error.
Don’t default on your monthly instalments related to loans and pay credit card dues. Making credit card payments often on the last day or closer to the due date lowers the credit score, since there is a risk of default on outstanding payment if delayed even by one day. Lastly, space out your credit applications and limit making several loan/credit card applications close together. Each time you apply for a loan or new credit card, financial institutions ask for the credit score, which is recorded. So, too many inquiries might mean that you’re credit hungry or you’re in some kind of financial trouble and are looking for credit to help yourself.
Q: With instant loans from fintech firms in the last couple of years, consumer borrowing has increased. What precautions must borrowers take to stay away from a debt trap?
A: According to our data, during 2016-18, consumer durable and personal loans have surged the most due to instant credit offered by fintech firms. They have increased at a compounded annual growth rate (CAGR) of 75 per cent and 46 per cent, respectively over this period. In terms of loan amounts, consumer durable loans grew by 11 per cent and personal loans grew by 40 per cent in the same period. We have seen borrowers taking multiple loans for specific needs such as travel, lavish marriage, medical emergency, etc.
Limit your credit utilisation to 30 per cent of the total limit available on your credit profile. Maintain a record of unsecured loans, which include personal loans and credit card dues. The interest rates are high on these loans compared to those on secured loans (home and car loans). So repay at the earliest to avoid getting into a debt trap.
Q: Why should millennial borrowers take credit scores and credit reports seriously?
A: According to our data, there has been a significant shift in the age profile of new borrowers. The share of millennials (26-40), in new lending has gone up by 4.6 per cent during the period 2015-18. This is because loans are available instantly to millennial borrowers with the rise in the number of fintech lenders. So, there is easy access to credit for young first-time borrowers.
Millennial borrowers must understand that the credit report is a summary of all the financial borrowings and the credit score is calculated after considering their level of debt and repayment history. The higher the credit score, the better the chance of getting a loan. In case you end up ruining your credit profile at a young age with multiple loans and defaults on your equated monthly instalments (EMIs), it will significantly diminish your ability to get loans in future.
Q: When should a consumer consider switching a loan or negotiate for lower interest rates from a financial institution?
A: When you have a good credit profile, it is advisable to determine the switching options available for you in the market, with 3-4 banks. Access the market for switching a loan once in 15-18 months for lower interest rates. Evaluate whether you can save on interest in the long term by switching an existing loan to another financial institution.
Also, check for lower interest rates with your existing financial institution based on your credit performance over the last one year. Negotiate for lower revised interest rates, for having improved your credit profile and making timely EMI payments. In many cases, a financial institution reduces the interest rate for existing consumers if negotiated well and a relationship is built with the bank.
Q: A large percentage of the Indian population today does not have access to credit because it does not have sufficient credit history or the credit score is too low. Is Experian planning to launch an alternative assessment model (new product) for such consumers?
A: For consumers who have low scores, improving their credit scores takes time. Similarly, for consumers who do not have a credit history, it would take time for building it. For such consumers, soon we are planning to launch the Experian boost service in India. At present, this service is offered globally by Experian. There is a way for consumers to improve their existing credit scores or build their credit profile by showing the payment history of their utility and phone bills. We will verify the bill amounts as well as whether these bills are being paid on time by the consumers. Once the verification of data is done and the consumer gives consent to add these bill payment details to their credit profile, an updated Experian score is delivered in real time. Consumers can then approach lenders, as they may be eligible for credit.