Money Wise: Is Your Credit Score 'Good Enough'?

A viral social media post by Zerodha founder Nithin Kamath about his own credit score sparked a series of conversations about the metric that lenders use to determine how much to charge you and even whether to lend to you in the first place. There are a lot of misconceptions about the score and so, I decided to speak to the oldest credit bureau – CIBIL – to find out what you should really pay attention to.

First things first, the credit score is a measure of your creditworthiness. There are a few credit bureaus that are responsible for generating a credit report – the outcome of which is the score. For TransUnion CIBIL, the score is out of a maximum of 900. On Money Wise this week, I asked Bhushan Padkil, senior vice president – direct to consumer business, at the credit bureau what a good score would be. He said that it depended on the lending institution, with some looking at a score close to 750 and others, 700. But the closer you are to 900, the better it is.

Now, there are a lot of theories about how your credit score is calculated and what affects it. Most importantly, your score is a dynamic reflection of your behaviour with credit. In other words, if you have never taken a loan, you won’t have a credit score. Some of you might think – like I initially did – that this is rather unfair. If you’ve consciously stayed away from debt – a smart choice – why should you not have a high score? The answer is – because the bureau does not know how you would have behaved if you had a loan. Not having a score does not preclude you from taking one – a lender would automatically move to look at other criteria – your age, your income, your assets, and sometimes even the industry you’re in to determine the stability of your cashflows.

But what affects your score? First of all, your savings bank balance and the punctuality of your payment of utility bills does not count. What’s most important is your regular repayment of your existing debt, the extent of debt you have and how much of your credit limit you’re utilising and for what purposes. The mix of your loans is also taken into account. If you have multiple credit cards and are maxing out your limit, while still paying on time, chances are you will see a fall in your score. The interpretation of this activity is that you’re unable to manage your finances with your existing cashflow and are having to max out your credit line.

Now here’s a big one – cancelling your credit card could well affect your score negatively. That’s because it could be perceived as the closing off of a credit line – if you only have one card. If you have multiple cards, closing a card that has a long history would also be a negative – simply because of the removal of that data when collating your score.

Ultimately, the score is not something to worry too much about. If you’re pragmatic and use your credit wisely, it will trend higher – perhaps not immediately, but over a few months.

Other Talking Points This Week

I also had an interesting chat this week on Your Money Matters with Sarthak Ahuja – investment banker and financial educator. I asked him about which income can be categorised as farm income from the perspective of the tax department. As things stand, if you’re able to prove that you grew agricultural produce yourself, you can claim that it is agricultural income. There are a few nuances, of course, and things could change once the new Income Tax Bill becomes a law.

What you may not have known is that if you have multiple sources of income, your agricultural income is counted along with your other sources to determine your effective taxation. As an example, if you had Rs 30 lakh of income from a farm and earned Rs 5 lakh from your job as a librarian, there wouldn’t be a rebate on the latter. In fact, you’d be taxed at 30% on that Rs 5 lakh, though the first Rs 30 lakh would not be taxed.

I won’t go into too much detail about the reducing fixed deposit rates – I wrote about that last week. I’ll simply say plan your investments to avoid reinvestment risk and look beyond banks to the mutual fund space for a few – better – options.

In other things you should consider reading this week, there’s a review of the movie ‘Materialists’ by my colleague Yukta Baid. She writes that love, actually is a financial decision. Find out why here.

Happy reading! And see you next week.

Alex