Data driven financing – The role of credit history in lending

Data-driven lending is the process by which a lender combines various digital datasets to understand the borrower profile and associated risks. This will allow the lender to make an informed decision and tailor lending solutions to fund creditworthy customers. And one of the crucial data points assessed by lenders before making lending decisions is the credit score.  

Credit bureaus calculate individual and company credit scores by consolidating data about the history of a borrower’s repayments, lawsuit verdicts, and pertinent financial information. The rating is updated monthly to reflect the borrower’s payment history accurately.

Credit scores vary between 300-850. Lenders consider this score a pivotal variable and a true reflection of the risk of lending to a borrower. The credit score is based on: number of loans, the total amount of borrowings, and repayment track record. Lenders use credit history to evaluate the lending risk by considering the chances of an individual repaying loans promptly. At Tata Capital, we offer several instant hassle-free customisable loans online using just the credit score and KYC documentation.

How is payment history and credit related?

Lenders use various parameters while underwriting the risk associated with lending to a borrower, such as a repayment history, total debt owed, debt to equity ratio, market standing, trade reputation, supplier relationships, customer equity, and many more. A credit score helps clarify a lot of these variables for underwriters.

Since lenders report late payments or missed payments to the Credit Information Bureaus, the credit report reveals the default amount and days the account was outstanding. These defaults can impact borrowers’ overall credit score for years.

If the borrower is a serial defaulter, their credit score will reflect a lower number accounting for the missed payments. Timely payments of interest and the principle will positively impact the borrower’s payment history. If the borrower pays all the bills on time and much before the due date, the credit history reflects a clean payment track record, which will help boost their credit score. The factors affecting the credit score and their weightage are –

• Payment History 35%
• Credit utilisation 30%
• Credit history length 15%
• Credit Mix 10%
• New credit 10%

As the common saying goes, “If a friend has a reputation for not paying anyone back, you wouldn’t want to lend them any money.”

The payment history accounts for the highest percentage in the credit score.  Types of account considered for credit history include:

• Home loan repayments
• EMI and interest payments
• Credit card payments, retail accounts
• Personal loan and interest payments
• Overdue or delinquent payments at present or in the past
• Number of loan accounts at present or in the past.

How can late payments hurt the credit score?

It’s not just the delayed payment that’s taken into account. Several factors are considered along with a late payment that impacts credit scores, such as:

• The severity of the late payment: Was the late payment amount a huge sum? Or was it a nominal amount?
• Timeline of the late payment: Was the late payment long back or was it recent?
• How frequent is the late payment: Are late payments a constant, or was it just a one-time issue? 

Additionally, the penalty for a delay by credible borrowers is higher than delinquent borrowers. For example, when the credit score is 780 (on a scale of 300-850), 30 days payment delay could drop the credit score to between 670 and 690. If the credit score was is 680, 30 days late payment could drop the credit score between 600 and 620.

The better the scores before a late payment or any other adverse credit event, the lower the scores because borrowers with higher credit scores are not expected to pay late. Whereas for a borrower with a lower credit score, the risky behaviour is already factored in.

Tips to enhance credit scores

Borrowers can improve upon credit history and credit scores with these few steps –

• Paying bills on time. The best way to start getting payment history back on track is to pay all dues on time. Setting up a budget to ensure the money necessary to pay bills on time will be helpful.
• Correct recent track record. The older a credit problem, the less it counts toward the overall credit score. If the borrower pays bills on time for a more extended period, even after having late payments in their records, the borrower can still improve their present and future credit score.
• Resolve incorrect filings. Sometimes a borrower’s credit score can be impacted due to inaccurate reporting. Contacting the credit bureau and resolving discrepancies can help correct the track record and credit score to reflect the true nature of transactions.

The bottom line is credit history plays a crucial role in lending decision-making. By building a solid payment history, borrowers can assure lenders of their intent and ability to service loans. In a data-first world, credit history will soon determine future borrowing capacity. Reach out to Tata Capital to know more about your credit eligibility and accessible loan offerings.