The definition of credit is the practice of borrowing money, either as a loan or for purchase with the promise of paying off the debt within a stipulated period of time. A credit score is defined as a statistical method to ascertain the likelihood of an individual paying back the money that is owed to them.
A credit score is essentially used by lenders, physical or online, to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. It is used to determine who qualifies for a loan, the interest rate, and up to what credit limit. Organizations like mobile phone companies, landlords, and government departments also use the credit scores of individuals to ascertain their creditworthiness.
Credit score is important to measure the risk assessment of an individual by the credit issuer. This is especially employed when an individual applies for credit like a loan, mortgage, or credit card. It allows the financial institution, which is extending the credit, to check the individual’s reliability in repaying the debt in a timely manner. A lower credit score can result in a loan rejection or even a higher interest rate compared to someone with a higher credit score. The credit score is valuable only when the data collected is over a long period of time.
Components of Credit Score
Components of Credit Score
There are various factors taken into consideration when evaluating the credit scores of an individual. These factors all add up to either a high or low credit score.
Credit payment history of the individual (35%)
Current debts of the individual (30%)
Duration of time of credit history (15%)
Credit Mix (10%)
Frequency of applications for new credits (10%)
Credit Scores Calculation
Credit Information Bureau (India) Limited (CIBIL), established in August 2000, is the first credit information company in India. It is CIBIL that allows credit ratings to individuals and sends them to banks for a loan applicants, based on which a loan is either sanctioned or not sanctioned.
It is a two-way information exchange where initially all credit information of an individual is sent to CIBIL by the banks. This information essentially pertains to the repayment of loans and credit cards. Information is then computed by CIBIL into a number range between 300 and 900. Scores lower than 600 and closer to 300 are considered low credit scores and may lead to applications for loans and credit cards being rejected. A credit score rating of higher than 600 ensures a higher possibility of getting a loan or credit card. CIBIL maintains a historical record of an individual’s payment behavior pattern which is sent to banks on request.
This service was launched with a view to reduce bad credits as well as to instil habits leading to high credit scores and teach financial planning to individuals.
How to Maintain a Good Credit Score?
How to increase a credit score
A loan or credit card application may be rejected even if all other criteria like age and monthly income are met, due to a low credit score. A credit score of 750 or above is usually considered a good credit score. There are certain steps that an individual can take to ensure that he or she maintains a good credit score.
1. Payment on Time
Payments that are made on time indicate a responsible and healthy attitude towards credit, which helps in maintaining a good credit score. The opposite, in fact, may reflect a negligent attitude with poor financial planning and can have a negative impact on credit scores.
2. Apply for Only One Loan at a Time
Every time an individual applies for a loan, the banks check the applicant’s CIBIL score that lowers for every check that is triggered. This effectively lowers the overall credit score. The more loans an individual applies for, the lower the credit score.
3. Updated Credit Card Payments
Credit card bills can be paid either in full every month or can be kept active by paying the minimum amount that is indicated by the bank. However, CIBIL considers the unpaid amount as overdue which indicates poor personal financial management. This reflects in the individual’s history every time a check is triggered. It is always better to pay the credit card bill in full to maintain a healthy credit score.
4. Don’t Close Credit Cards
Simply put, if all credit cards are closed, there is no avenue to build a credit history to lean on when a loan is required. It is ideal to maintain at least one credit card and maintain a healthy repayment history with the card to build up a good credit score.
5. Refrain from Payment Defaults
If there is an existing loan on any credit cards, ensure that all payments are made on time. Any misses or default gets recorded in the credit history can negatively affect the credit score and may also result in a loan being rejected.
6. Manage Expenses within the Earnings
When the spending exceeds the earning, it gives rise to credit which can lead to more spending and thus a collection of debt. It is wise to spend within a limit that can be supported by the earning which also adds to the overall credit score.
7. Balance the Loan Types
It is a healthy habit to keep a mix of loans. The idea is to balance secured and unsecured loans. If the loans are heavier on the unsecured credit side, personal loans or credit card loans, it acts as a red flag and makes lenders cautious about granting further loans.
Conclusion
The importance of maintaining a healthy credit score cannot be ignored. It is a gateway to getting a home loan or a personal loan as and when required. A high credit score also helps an individual in getting credit cards that is also another way to build a healthy credit history, eventually making a positive impact on the overall credit score of an individual.
FAQs
What is a good credit score in India?
A credit score of 750 and above is considered a good credit score in India.
Can I get a loan or credit card with a credit score of 500?
A credit score of 500 is considered to be a poor score, hence it is difficult to get approval for a loan or card with this score.
What is a CIBIL credit score?
CIBIL score is a three-digit numeric summary of your credit history.
What is the toughest credit score?
850 is considered to toughest credit score to achieve.
If you’ve purchased something online, you may have observed the feature to buy now and pay later, that’s becoming increasingly common across e-commerce platforms. And you may have observed this feature in offline places as well, such as retails, and for several folks, this choice is very effective because usually, you’d have to save up until you could purchase that fancy new pricey item that you want to shop, no one intends to do that, notably if it’s on sale now and won’t be in a couple of months. We need things right now.
We wish to shop for them now and pay for them subsequently, and the typical approach was a form of credit or a credit card. However, obtaining a credit card in India is not always simple, and when you do, you’ll be hit with a slew of interest charges. You are mysteriously in debt, if you’re not cautious, that credit can take ages to pay off.
So, either you save for quarters or you go into debt, and that’s where buy now pay later comes in. The BNPL startups are capitalizing on the appeal of paying for stuff later, just like you’d with a credit card and aiming to make it convenient.
I stated earlier about snazzy new valuable stuff such as mobile phones, tablets, and televisions, but BNPL is now becoming accessible for daily necessities as well. Groceries, apparel, and even diner food Zomato and Swiggy are now providing BNPL as an alternative, and these types of BNPL use scenarios are probably a major root of rivalry right now for existing companies in the lending space, with the expected count of BNPL users in India reaching million by 2026.
By 2026, this will account for nearly 7% of Indians. Cardholders now contribute to just over 2% of India’s populace or 30 million, and it’s more than twice the average of BNPL users, which is between 10 and 15 million, and that number is burgeoning.
So, if you’ve not guessed, BNPL and credit cards are related in terms of the services they provide. Credit cards and buy now, pay later cards (BNPL) is a type of credit. This is a debt, not a credit card. You’re deriving funds from a 3rd person in both instances. It could be a BNPL firm, one of the financiers with which they have affiliated, or a credit card issuer, which is typically a bank. However, the issuance of credit cards and BNPL differs significantly.
So, if you’ve ever applied for a credit card in India, or if you already have one, you’ve most likely received a call or an email from a bank salesman congratulating you on your new card eligibility. Moreover, what’s happening here is that your contact details, that is linked to your identity, are now in circulation among most monetary organizations in India, as well as a few swindlers, but there’s a good chance that if you seek to get one of these cards, your request will be denied.
Irrespective of what the sales representative told you, acquiring a credit card in India is seldom as simple as the sales representative makes it seem. You must be beyond a certain age, you must meet an income cap, which implies you must have a career with a decent payslip, and you must most likely have a high credit rating, which makes it incredibly tricky for novel applicants into India’s lending market, folks residing in remote areas who may not even have a proven credit file, and same goes for freshmen who have just begun.
They’re steering clear of defaulters. Folks they believe pose an undue risk. Essentially, they maintain their NPAs minimal by upping the ante for their clients. But once you’re a client and obtain a credit card, the hardships and obstacles do not end there so you have to pay for your credit card.
Some credit cards charge a yearly fee only to own the card, close to a membership, but those that don’t typically cost exorbitant interest and a slew of other fees for stuff like exceeding your credit line, reimbursing your minimum deposit late, and cash withdrawals from your credit card to your bank. When you add up all of these obstacles to entry and client pain points, it’s no shock that many Indians dislike credit cards.
Brands such as Slice, Zest money, Simpl, Lazypay, and Uni are limiting the barriers that credit card companies have raised. In India, almost anyone can BNPL; all you have to do is offer information such as your PAN and Aadhar number. Rather than focusing on credit scores, these BNPL companies are using their algorithms to identify how much loan you must be awarded based on your previous transactions and site, once you’ve been a BNPL client for a while and are in good condition and have billed your loans, they’ll also boost your spending limit.
Another element to take into account is the timeframe. Card issuers anticipate that you will decide when to pay off your loans. They offer you a monthly minimum payment that you should return to them, principal and interest, but again, it is up to you to pay back the loan, and many struggles with that freedom. They reimburse the bare minimum without creating much of a hole in the principal, which is the original loan value before interest costs.
With BNPL, credit payout is spread out over a set period, typically a month or two, using a process named as EMIs. If you pay these monthly installments, your BNPL loans will be paid off after a set period. Is this to say that the BNPL plans are interest-free? Both yes and no. It depends on the console and BNPL firm from whom you are accruing.
The longer the loan term, the larger the interest rate. If you choose a short-term BNPL tenure, such as 15 – 45 days, you will most likely avoid paying any interest if you pay back on time. You’ve essentially just spread out a fee that would’ve been made immediately over a period of several weeks. However, if you choose a longer time frame of 3 months to a year, your interest rate could range between 10 and thirty percent, based on a range of factors. However, this is made upfront so that BNPL clients are cognizant of deferring fees for a longer time.
Card issuers, on the other hand, allow you to dig yourself a big trench. One credit transaction here, another there, and you’re unexpectedly trying to cope with minimum payouts, while your loans continue to increase as interest compounds. So, BNPL appears to be the clear victor here, correct? Isn’t it a type of loaning relevant and personalized?
That’s the story that BNPL fintechs want you to believe. But let’s look closely at how these companies work.
Let’s begin with the final consumer, who is acquiring a product now and paying later from a vendor who is an offline vendor, such as a shop owner, or a virtual vendor, such as a D2C firm or an eCommerce storefront. Then there’s the BNPL supplier, who is responsible for supplying the tech here. They examine the final consumer using sophisticated algorithms and decide how much to lend them, but this credit isn’t flowing from their wallets, at least not most of the time. Rather, these BNPL businesses have teamed with lenders, either nonbanking financial firms or full-fledged banks.
So, here we have a true overview of the consumer, vendor, BNPL mediator, and bank or NBFC. Often the BNPL vendor is an NBFC, and that’s just one of their many product lines, and they’re often a Fintech firm, such as Paytm, which offers BNPL, and often the BNPL company is also a vendor, such as Flipkart or Amazon, which have their specialized BNPL solutions.
So the concern is, how do BNPL firms earn money? There are a couple of income streams.
The first one arises from vendors such as card issuers and point-of-sale (POS) providers. BNPL firms charge margins ranging from 2 to 8% of the original cost. The vendor is fine with it as they see the chance to network with the BNPL supplier. For starters, they experience a rise in conversions and an average deal worth because clients who previously could not afford high-ticket items in their shop or marketplace can now do so. So, partnering with the BNPL firm facilitates vendors with more clients who spend thousands, and the best feature is that they don’t bear any of the risks.
The BNPL firm earns on behalf of a client. As a result, the monthly EMIs buyer pays do not benefit the vendor. The vendor has been fully paid; rather, the final consumer pays the EMIs to the BNPL firm, which accepts all of the peril.
And what if the end-users are unable to meet their monthly EMIs? Since many BNPL firms charge late fees, this is where the 2nd income stream comes in. As per bank bazaar, these fees vary from 2 to 8 % of the foremost loan balance, or they can be a fixed fee ranging from 0 to 750 INR.
To try to get these debtors to pay up, it’s almost like a punishment. It’s worth mentioning that some BNPL companies don’t cost extra payments and instead prefer to start slowly to avoid defaulters. They initially give an amount owed that they can easily lose, and if the client repays them, their line of credit is gradually increased. If a payout is late, the user’s ability to repeat procuring items through that BNPL site is revoked, and the user’s credit rating suffers as well.
Challenges Faced by BNPL Clients and Customers
The industry is facing a lot of issues. Many BNPL clients still have no idea what a credit rating is. They are unaware that avoiding paying off their BNPL dues on time will permanently harm their fiscal identity. They have no prior loaning experience. They haven’t been a client of a lender, and that’s where we soon run into troubles because, as I previously stated, BNPL companies make it extremely simple to obtain a loan. Even for those with no previous fiscal expertise and little financial self-control.
Sadly, some folks can spiral out of control. Without realizing it, they are overspending than they can manage to cover later. Of course, BNPL parties are aware of this, and they argue that it’s early in the season. Because debt users in India are low, they don’t have huge data to deal with, so they’re developing concepts.
They are steadily accruing a ton of information on first-time Indian debtors, and as they derive insights, they are reworking their equations, working with first-time debtors by starting with small loan confines and then providing larger loans to reliable debtors and identifying unreliable ones.
To put it another way, they’re laying the foundations for enlightening the fiscal reliability of a sizable undiscovered segment of India’s populace. It’s like a public good, or so they’d describe it.
Customers, particularly those who are not tech or monetarily savvy, are uninterested in these concepts. This bird’s-eye view means nothing to them. When they seek themselves suddenly in a sea of loans, they fear, curious how a relatively harmless buy now pay later forum got them there and how no one will offer them a loan to pay off their other line of credit since their credit rating, which users didn’t realize they had, has now turned red. They may lose hope of coming out of the financial mess.
This, of course, will not cause BNPL entities to slow down. At least not without the government’s help. Indeed, as more capital is poured into buy-now-pay-later businesses, the situation is only heating up. To stay viable, BNPL firms must connect with more prospective customers, either by entering untapped communities in remote areas or by poaching clients from rivals by giving them even simpler loans.
You can now adhere to BNPL from 4 or 5 multiple devices and collect up to one lacs with surprisingly fewer formalities and no payslips. There are even reports of BNPL firms failing to perform precise KYC or credit bureau checks. They’re expanding so quickly that they can’t extend their due diligence, and there have been reports of failures not being disclosed to credit bureaus.
To be honest, matters in India’s BNPL space are currently out of regulation. Unapproved credit institutions are springing up in the lack of sufficient regulations. For instance, in early 2021, an influx of Chinese lenders apps harassed and humiliated clients into repaying loans at exorbitant daily escalating interest rates by using user information and phone authorization.
The RBI discovered that of 1100 lenders apps in India, 600 were illegal, while these 600 unauthorized apps aren’t all BNPL apps, they are a manifestation of a bigger issue in the loaning space in India right now. Financiers and loan mediators are throwing caution to the wind in favour of expansion at any cost.
RBI Working Group Report on Digital Lending
The RBI’s online lending working group is developing innovative forms for safer business exchanges. Although the online lending market grew 12x between 2017 and 2020, the RBI did not govern several of the new businesses, according to the latest study.
Typically, these companies and apps collaborate with banks and NBFCs to assist. As a result, prompt loans are becoming available at the expense of higher risk. It has also led to client excessive debt, legislative arbitrage, and high costs.
The report reveals such flaws while also offering a great structure for the industry. The study’s pertinent points are explained below to provide a clear grasp of the proposition.
Differentiation among LSPs and BSLs
Loan Service Providers (LSPs) and Balance Sheet Lenders (BSLs) are separate entities (BSLs). LSPs are apps that offer clients borrowing choices. They don’t get to be explicitly controlled, so they must collaborate only with governed financiers that can offer the assistance.
BSLs, on either hand, lend money and stably claim credit threats. They always are governed. This difference enables LSPs to handle the front-end expertise, whereas BSLs handle compliances and threats.
Ban On FLDG
An FLDG tool, or Ban On FLDG First Loss Default Guarantee, enables ungoverned companies to give credit to borrowers and claim credit risk. The study advised against using a trojan horse entry.
Many fresh lenders face difficulties because their systems are based on shadow lending. This part entails neo-banking and Defi (decentralized finance) concepts for a modal test. Innately, the study guides that only governed agencies should be allowed to take credit risk.
Supervisory arbitrage must be eliminated
The study recommends classifying all credit lines as credit instruments and eliminating supervisory arbitrage. Eg: most BNPL providers treat this feature as a purchase rather than a loan, and thus lack adequate KYC computation. They are unrelated to the credit bureau.
Client Protection
In some cases, the fees and rates are as large as 100%. The working group suggests a few steps to safeguard consumers from such practices. These are some of the suggestions:
Use a proper APR for all interest and fees.
STCC – must conform to relevant standards to avoid exorbitant fee rates.
Limit high-risk, very short-term debts with no tranches.
Recapitalization and over-indebtedness should be limited.
Insurers must also make sure that the LSPs associated treat debtors fairly, particularly in collection practices. To verify trusting clients and a healthy ecosphere, all forcible actions are avoided.
Data Security
The info is owned by the customer, not the institution. All critical loaning situations require clients’ assent to use their data. This includes any e-commerce system that supports customer info to make underwriting choices. This improves data safeguards while retaining customer trust.
SRO And DIGITA
The study recommends that the RBI establish a Self-Regulatory Organization (SRO) to regulate operations and set guidelines. It also suggests developing DIGITA (Digital Trust of India Agency). DIGITA will meet the basic specifications for verification of conformance. Companies that have not been accepted by DIGITA will be considered non-compliant.
What Should Customers Be Wary of When Using BNPL Apps?
To begin, consumers must ensure that the app they are installing is from a licensed lender. If a firm does not have an RBI license, it must simply define under whose license it is selling products. Before installing, look into who is releasing the app, visit the site, and ensure it is a well-established and certified Indian corporation.
Second, if the firm is licensed, see if it explicitly shows this on its webpage, along with the RBI regulations that it adheres to, such as the grievance handling framework and interest rates. Furthermore, never install apps that request contact info because they are used for duress.
Third, while most BNPLs assert no charges or nil interest, you must learn the real loan amount. Even if firms claim zero percent, they are required to disclose their IRR – Internal Rate of Return – so buyers must ensure that the firm or app discloses all these for their safety.
Conclusion
BNPL is a valuable tool, but it should not be used for every acquisition a buyer intends to make or for daily purchases, as this would be over-leveraging oneself.
However, when handled efficiently and sensibly, the fact that rather than trying to make all of the payouts now or using a credit card to purchase, you are simply getting an option to acquire an item for nearly the same cost and drill down into 4-5 payouts is an effective device to have.
This is the benefit that BNPL firms provide, and it is the reason for the rapid acceptance because clients realize and require it. Buy Now Pay Later is an ideal, smooth payment system with vigilance on the part of the users and accountability on the part of the financiers.
FAQs
What are the risks of BNPL?
BNPL companies do not charge interest but charge high late fees which many consumers fail to pay and are later mounted in huge debt.
Is BNPL regulated?
No, Buy Now Pay Later companies are not regulated in India which has resulted in their growth and scams.
What is a BNPL company?
Buy Now Pay Later companies are companies that allow consumers to purchase the product and pay later in small installments.
In the last 7 to 8 years, the fintech industry has experienced immense growth all over. A countless number of fintech startups have begun their journey in the last few years and have already put their name on the list of top fintech companies.
As of 2020, the global market size value of the fintech industry is $110.57 billion. Fintech or financial technology is a form of technology that is challenging the traditional method of providing financial services to people.
Now in the fintech industry, there is a thing called credit score, and everyone is dependent on them, including consumers, business ventures, and purchasers. In this article, we will learn how credit scores play an important role in the fintech industry. So without any further, let’s get into the business.
“The major winners will be financial services companies that embrace technology.” – Alexander Peh
In simple terms, a credit score is a number that decides your creditworthiness. The number is between 300 to 850. The more your number is the more is your creditworthiness. This score actually depicts your chances to pay off the money that you owe to the lender.
This helps any kind of financial institution to understand if you are dependable enough to pay the loan if they lend you. If your credit score is high, then the chance of getting a loan and credit increases for you, if you want to buy something. If the score is lower then, the chances of getting a loan decrease.
There are different credit bureaus that check your credit scores and make a report on it and send it to you. The reports are based on many factors. There are three top and popular bureaus that count the credit scores of people.
There are there main international credit score bureaus that assess people’s credit score and they are:
Equifax
Experian
Transunion
Fintech Industry in India
The fintech industry in India has taken a huge turn in a few years, it has changed the way we used to enjoy financial services in the past. Currently, it wouldn’t be wrong to say that India is the hotspot for fintech startups.
As of 2021, the market size is $31 billion and it is said to be the third-largest in the world. By the next five years, we are going to see 22% growth annually. The country has 1860 startups in the fintech industry, out of those 17 have already got the Unicorn status. In the last two years, massive numbers of people have adapted to digital payments systems for any kind of transaction, and it’s only going to increase.
Role of Credit Scores in Fintech
The first thing the financial institution will do after getting your, request for the loan, is to check your credit history. If your credit score is good enough, then it will provide you with the loan and apart from that, loads of rewards and benefits. It is very good support for the fintech companies who are lending money to the borrowers.
How Credit Score is Calculated?
The way of calculating credit scores varies from bureaus to bureaus. They have their own model that they use to get the result. There are five things that are taken into consideration during the evaluation process and they are:
The credit scores help you in two ways and they are:
Your credit score lets you know where you are lacking, the complete report gives you an idea of how you can improve in that area to increase your score. The report consists of all the transactions that you have made.
Through a good credit score, you are eligible to get attractive offers on loans and credit cards. A credit score of 750 and above is the best to get good offers.
How to Improve Credit Score?
Pay your debt before the due date every month.
Don’t ignore your overdue bills pay them as soon as possible.
Keep in mind the credit card you use and its type.
Don’t spend too much on your credit card. Be aware of your spending and try to cut the unwanted ones.
Benefits of High Credit Score
A high Credit score has several advantages, some of which are listed below.
When your credit score is higher, you are eligible in front of banks to get loans and credit cards at considerably lower interest rates. Plus there is a chance of a discount on the processing fee of a high loan amount.
Those who have higher credit scores have a lower risk rate of not paying their debts. It basically means the chances of your loans getting approved are higher.
You are eligible for a credit card that offers good rewards and other offers like cashback as well.
Your credit limit increases, if you’re worthy, then the creditors know that you will pay your debt on time, this increases their trust which in return increases the credit limit.
Attractive Car insurance and home insurance rates are offered to those with good credit scores.’
Less number of documents is needed by lenders from you.
Guarantors are not needed when you are taking a loan if you have a good credit score.
Getting loans or credits can be quite a hassle but if you have a good credit score, then lenders won’t hesitate to lend you the money. Fintechs take the help of credit scores and realize who to lend money and who do not. The credit scores assure the fintech, about your credit risk and the money that they are about to lend,
FAQ
Why do financial institutions look at your credit scores?
Financial institutions take the help of credit scores to determine what kind of borrower you will be and if you are creditworthy or not.
Who uses credit scores?
Credit scores are used by financial service givers, especially lenders.
What is a good credit score?
A credit score of 700 or above is a good one as achieving the perfect 850 is quite hard.
What are the factors that affect credit score?
Payment history, Amount owed, Credit history length, Credit mix, and New credit are the factors that affect credit score.
