What is credit rating, and how is it calculated?

For an entity, be it a partnership firm or a company, looking to avail a loan or any other credit facility, knowing what is credit rating or score, becomes essential. Such information gains all the more criticality when the credit facility is unsecured, such as a personal loan.

It is one of the crucial factors which determine whether a financial institution will approve a loan application sent by such an entity. Moreover, it also impacts the loan amount to be sanctioned and other terms of service.

Understanding credit rating – Meaning and importance

The credit rating of an entity indicates its creditworthiness based on past credit records. Similarly, in the case of individuals, such rating is better known as CIBIL or credit score. Financial institutions check this rating whenever one applies for a loan. Any score which is above 750 is considered to be a good credit rating or score. 

Different credit rating agencies in India

The function of credit rating agencies is to assign a credit score to different individuals and businesses on the basis of their repayment behaviour and creditworthiness. A 3-digit score is thus generated, followed by a report after the evaluation of the concerned individual’s credit history. It is this rating or score that will be considered by lenders in extending advances such as a personal loan.

Some of the well-known credit rating agencies in India are – 

1. Credit Rating Information Services of India Limited (CRISIL).
2. ICRA (previously known as Investment Information and Credit Rating Agency of India Limited).
3. India Ratings and Research Pvt. Ltd.
4. CARE or Credit Analysis and Research Limited.

While considering what is credit rating and the efficacy of the rating agencies, it is important to note that there are certain common functions of these bodies –

• Maintenance of borrowers’ credit information.
• Borrowers’ portfolio review provided to lenders.
• Extending risk management tools to members.

Types of credit rating – A look

The credit ratings assigned by the agencies may vary a little. Thus, there is no standard rating guideline for the types available in case of businesses. Nevertheless, when it comes to assigning individual scores, the following bifurcations are adhered to when lenders check one’s creditworthiness.

• 750 – 900: Exemplary credit history, which allows the borrower to avail loan at best market rates. For example, a borrower can avail a better interest rate for a personal loan with a credit score above 800. 
• 700 – 750: Indicates good track record of past repayments, but lenders may need to conduct further credit analysis. 
• 550 – 700: Irregularities in past payments often render the CIBIL score as low. Loan can thus be extended only after a rigorous credit check. 
• 300 – 550: Poor score due to past delinquencies, write-offs, and over leverage. It results in a considerable difficulty in obtaining a loan from any bank. 

Irrespective of the credit rating agency, higher the score, stronger is a borrower’s financial profile. For instance, if you are planning your living room renovation or any other purpose when availing a loan, a high credit score ensures that a loan can be obtained easily.

Calculation of credit rating 

The composition of an individual’s score is primarily dependent on his/her loan payment behaviour. The factors responsible for calculation include –

• • History of payment.

• Credit mix comprising secured and unsecured advance.  

• Number of loan enquiries for an individual. 

• Extent of credit utilisation. 

Thus, a detailed understanding of what is credit rating should include a contribution of all these factors. 

Such information also enables a borrower to take the benefit of a quick lending process as provided by lenders like Bajaj Finserv when they apply for a personal loan. 

The financial institution also provides pre-approved offers on a range of financial products like business loans, personal loans, etc. to make funding hassle-free and less time-consuming. You can check your pre-approved offer by entering your name and contact number. 

Furthermore, if the credit score is found to be low, adopting active measures can help improve such rating over time. For instance, you may want to maintain a balanced credit mix, keep credit utilisation low, and adopt such suitable measures.