Often loan applicants wonder if they meet the eligibility criteria and earn enough to repay the dues then why should their credit history matter at all. Unlike before when loan applications were accepted based on subjective parameters, now the process has become more objective. Thus credit scores now are the first step to getting a loan application approved if one is applying to a private/public mainstream financial institution. A low CIBIL score could meet an outright rejection of the application. So why does this happen?
Nisha wanted to apply for a personal loan as she wanted some extra money for her wedding. She applied for a loan but it was rejected due to a low credit score. She decided to approach one of the lenders that were willing to offer a loan without credit check. She was shocked to see that personal loan interest rate at which this lender was offering a loan was exorbitant, much higher than the prevalent market rate.
So as we said earlier a low score could mean that your loan application is rejected right at the first step or you could be forced to borrow at higher rates. This happens because a low score is an indicator of low creditworthiness and high risk in an applicant.
Let's understand this in detail. When a lender gives a loan they do so with the faith and expectation that the borrower will return the borrowed amount in a timely and disciplined fashion. In order to ensure this they have certain eligibility criteria which includes establishing their identity and also their repayment capacity.
However there may be instances when the borrower does not pay, not because he/she cannot afford to do so but because he does not want to or is not disciplined enough. So how does the lender establish the creditworthiness of the applicant? Till a decade back there were more subjective ways to deal with it, the lenders lent to people who could produce a guarantor or were known to the bank staff and so on.
The more objective way of dealing with this is looking at the credit scores of applicants. The credit report of an individual has details about all his loans and credit cards, their payment history, how much is owed, what is the credit utilization ratio and so on. Based on various parameters a score is calculated which indicates the credit worthiness of the individual.
CIRs don't carry recommendations; they just give a detailed view about the credit behavior of a person. Thus based on the credit history, the prospective lender can decide whether to accept the application or not. A low score would mean that the applicant is high risk and is likely to default thus the lender may choose not to accept such an application.
The answer to this will depend on two factors, how low the score is and which kind of loan is one looking for. Any score below the range of 700-680 is considered a low score. However if the score is still above 600 and the applicant has a valid explanation for their low score there could be some hope for them. Below 600 could spell real trouble.
Another factor is the type of loan. Getting secured loans like an auto loan with a slightly low score is possible if the lender agrees to make some additional checks or the applicant could get a guarantor. Here the lender has asset as a safety net if the borrower defaults.
Things might be tricky if one is looking at getting an unsecured loan with a low score. So getting a personal loan for low CIBIL score will not only be difficult but also very expensive just as Nisha discovered in the above example.