How Credit History Affects Loan Approvals & Your Borrowing Power
When you apply for any kind of loan or a credit card, your current credit score and credit history play an important role. It gives the financial institutions a fair idea about your repayment history and creditworthiness. which enables theythem to determine your eligibility for the loan. Maintaining a good credit history by making timely payments increases your chances of quick loan approval.
In this guide, let us understand the significance of credit score for loan, and how your credit payment history affects your eligibility for the loan. Read on!
What is a credit score?
A credit score is essentially a three-digit number ranging from 300 to 900 representing your creditworthiness. Credit bureaus calculate your credit score based on factors such as your credit history, total debts, payment patterns, credit utilisation ratio, etc.
A higher credit score reflects your responsible credit behaviour and indicates to lenders that you are more likely to repay the loan on time. Lending organisations, such as banks and NBFCs (non-banking financial companies), refer to your credit history while reviewing your loan application and consider the score to determine the level of risk involved in extending the loan to you.
What is credit history?
In simple words, credit history is a record of how you have managed your debt, including credit card accounts and loans. The credit history captures all the credit related transactions including inquiries for new loan as well as any credit facility taken bythe borrower. This is a record of every repayment or delay in payment since the first credit facility till date.
How does credit history affect loan approval?
When you apply for any loan, the financial institutions do a thorough credit history check, and here is how it affects your loan eligibility.
- Better chances of loan approval
If you have always maintained a good credit score history, and your score is more than 750 when you apply for the loan, the lending institutions will perceive you as a low-risk borrower and this will smoothen your loan application process. However, the minimum credit score required for the loan may vary from one lender to another.
- Faster processing of loan
Having a good credit history allows you to get approval for the loan faster. You may be required to provide only basic documents and get the disbursal faster, sometimes on the same day of applying for the loan depending on the lender’s policy.
- Lower interest rate
Unarguably, the most significant benefit of maintaining a good credit history is that financial institutions offer loans at a lower interest rate to applications with high credit scores, allowing you to save a lot of money on interest payments through loan tenure.
Challenges you may face with low credit score and bad credit history
Although it is not impossible to get a loan with a low credit score, you may face some challenges, including:
- Repeat rejection
A strong credit score enhances your eligibility for loans, as many financial institutions prioritise borrowers with a consistent repayment record. However, there are some lenders that may approve your loan even with a low credit score, but they may charge a higher interest rate than the rate offered to others to compensate for the risk associated with extending the loan to you.
- Lower loan amount
Most financial organisations prefer lending to people with a good credit history, but if you have missed your EMI (equated monthly instalment) payments in the past or opted for debt consolidation in the past, the lender may perceive you as a high-risk borrower and may only approve only lower amount than the requested loan amount.
- Higher processing fees
Generally, lending institutions charge a higher processing fee on loan requests from individuals who have a low credit score.
- Collateral or guarantor needed
Some lenders may ask you to bring in a guarantor who can sign the loan agreement on your behalf if you do not have a good credit history. This is mainly to offset the risk associated with lending you. Alternatively, the lender may ask for collateral against the loan. In this case, you may have to pledge an asset with the lender. The asset acts as security for the lender against the amount you borrow.
How to improve your credit history and credit score?
Now that you know what is credit history and how it affects your loan approval, let us look at the things you can do to improve your credit history and credit score.
- Make all your loan EMI payments on time, i.e., on or before the due date consistently, throughout the loan tenure.
- Keep your credit utilisation ratio low.
- Avoid applying for multiple loans within a short period.
- Have a good mix of both secured and unsecured loans in your credit profile to build a healthy credit history.
- Review your credit report periodically, at least every three months. This will help you report inaccurate information that may affect your credit standing in a negative way.
Conclusion
A strong credit history and high credit score help you get approval for your loan applications faster and sometimes, maybe with better terms and conditions to align with your financial requirements.
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