The difference between credit score and credit risk assessment can often confuse both retail and institutional customers. Yes, the terms are fairly similar to each other and often sound interchangeable. They both provide a measure of a borrower’s credibility as well. But there are certainly differences on how they operate, how they are calculated and their impact on interest rates. Let’s take an in-depth view of both the concepts and put all confusion to rest.
A credit score is a numerical score that evaluates a person’s creditworthiness based on their credit history. Lenders often use this number to evaluate the probability of debt repayment on the consumer’s part. It ranges from 300 to 850, and logically the higher is someone’s score, the higher is his/her financial trustworthiness.
Though there are many credit scoring models in use, the most commonly used by financial institutions in India is the CIBIL score, which ranges from 300 to 900.
The credit score plays an important role in the lender’s decision to offer credit. Borrowers with credit scores below 700, for example, are considered subprime borrowers. Lower credit scores can be among the leading factors affecting your personal loan interest rates. Banks charge a higher interest rate on loans to subprime borrowers, than they would charge a conventional borrower. A person with a good credit score can also negotiate a lower interest rate when borrowing from personal loan institutions.
What factors impact your credit score though? Credit scores calculations are based on a variety of factors:
- Credit History, which accounts for 30% of CIBIL score calculations.
- Credit Utilization, accounting for 25%.
- Credit Duration, accounting for 25%.
- Miscellaneous factors like how many applications have been made in the past account for the rest 20%.
Having a good credit score does not automatically mean that a loan application will be approved, but it increases your chances significantly.
Credit Risk Assessment
Credit risk assessment involves estimating the probability of loss resulting from a borrower’s failure to repay a loan or debt. Traditionally, it refers to the risk that the lender may not be able to receive the principal and interest.
Credit risk assessments are carried out on the borrower’s overall ability to repay a loan according to its original terms. To assess credit risk, lenders often look at the 5 Cs:
- Credit history,
- Capacity to repay,
- The loan’s conditions and
- Associated collateral.
Credit risk assessments have replaced credit scores as a way of checking a consumer’s trustworthiness, with many financial institutions establishing separate departments for assessing credit risks. They are a key factor for large loans provided by banks, financial institutions and NBFCs, such as mortgages, credit card bills etc.
CRA has a significant impact on the interest rates, as higher the credit risk perceived, higher will be the interest rates for the capital. Creditors/banks can also decline loan applications if the risks are too high. In a nutshell, better credit ratings for borrowers attract lower interest rates.
CRISIL (Credit Rating Information Services of India Limited) and ICRA Limited are two of the most famous credit rating agencies in India.
Credit scores and credit risk assessment are important factors for a borrower. They are impacted by past credit history, but financial institutions are beginning to lean towards credit risk assessments when dealing with loan applications. CRAs are more comprehensive and provide a better overall idea about a borrower. Banks and big financial corporations are likely to use credit score as an important, perhaps leading factor in their assessments, while new-age lending portals – like EarlySalary offer personal loans using a broader approach to credit risk assessment, that does not rely on just credit scores. EarlySalary factors in your ‘Social Worth Score’ – based on a range of factors, allowing it to arrive at a more accurate estimation of your borrowing capabilities. Looking for an instant personal loan? Get started with EarlySalary here.