What Is a Credit Rating? Know The Importance Of Credit Rating And How It Works
Whether one is applying for a personal loan or any other unsecured advance, credit rating is an essential parameter that is taken into account to assess an individual’s creditworthiness. It is a method of analysing the credit risk involved in lending to a borrower by evaluating credentials such as income, past payment histories, etc. of an entity.
There are several types of credit rating that these agencies provide like bank loan credit rating, corporate debt credit rating, mutual fund rating, public finance rating, to name a few.
Understanding credit rating
Credit rating is provided to an entity as a statement. It carries a report of the financial history with details of past borrowings, lending, assessment of creditworthiness, statements of assets, liabilities, etc., which collectively determine a respective entity’s ability to meet debt obligations. Usually, these details are calculated and presented by official agencies.
Credit rating in India is carried out by ICRA, CRISIL, CARE, etc. These statements prove beneficial for credit lending agencies to analyse the creditworthiness of an entity and also understand the risk involved in lending credits to them.
Borrowers are also often perplexed between the terms ‘credit rating’, ‘CIBIL score’, and ‘credit score’. The difference between CIBIL score vs credit score lies in the fact that CIBIL is one of the four credit information bureaus in India, and the term CIBIL score is the three-digit summary of a borrower’s credit history provided by the particular institute, ranging between 300 and 900.
On the other hand, the term credit score stands for the score that is generated by any credit information bureau in India to determine the creditworthiness of an individual borrower. Credit scores like CIBIL score are essentially important for personal lending. Credit rating, contrarily, refers to the assessment report of creditworthiness for business entities issued by the concerned agencies.
Importance of credit rating
The importance of the various types of credit rating in regards to both lender and borrower are explained below.
Benefits for the borrower
- The credit rating of a borrower is essentially the primary determining factor of the interest rate that is levied upon when availing finances. The interest rate of all financial institutions is not similar. However, if your credit rating is high, you will be eligible to get the best interest rates for your personal loan or any other advance.
- If a borrower has a high credit rating, then he/she will be able to enjoy hassle-free loan approval along with a high funding value as per his/her repayment capacity.
Further, borrowers can also use a personal loan calculator to compute their creditworthiness from lender websites like that of Bajaj Finserv.
Eligible candidates can also avail of pre-approved offers from the lender to experience hassle-free loan processing. These offers are available on several financial products, like business loans and personal loans. If a borrower is already an existing customer, then he/she can check their pre-approved offer by just providing basic details like their name and phone number.
Benefits for the lender
- The reports offered from analyzing various types of credit rating allow the lender to gauge the creditworthiness of a borrower and help determine the risk margin involved in lending.
- Also, the lender will be able to make a prudent decision about the rate of interest that they should levy and also other privileges that they can offer to the borrower.
How does credit rating work?
Credit rating agencies in India have a specialised algorithm which they keep track of to determine the creditworthiness of individuals as per their financial records. The prime factors that they note are the credit history, credit utilisation, credit type, and duration, along with the length of credit exposure. These agencies usually collect information from several financial institutions on a monthly basis for report creation.
Finally, they assign the borrowing entities with a high or a low rating or score based on the reports prepared by them and the type of credit rating applicable. This report is, inturn, utilised by the financial institutions to make a decision about financial transactions like buying bonds, extending loans, investing money, and others.
Generally, a credit or CIBIL score greater than 750 is considered as a reflection of reliable financial history. Therefore, reputed financial institutions ensure that the credit score or rating of a borrower is more than 750 when assessing the applications for unsecured advances like a personal loan. Make sure to check your rating before applying and take necessary measures to improve it for easy loan access.
