Ever wondered what a credit score is and how it applies? Well, we could start by saying that it helps banks mitigate risk from one of its major sources of revenue; Loans.
Banks provide loans to customers who are required to pay back with interest. This is very lucrative. However, getting people to pay their loan debts is often a serious challenge.
The credit score system helps address this issue in two ways. First, it identifies loan-worthy customers. Secondly, it helps inform banks of appropriate loan amounts per individual.
What is a Credit Score?
Credit Score, or SMARTSCORE, is a number-based scoring system used to determine if an individual who needs a loan will be able to repay it.
A credit score ranges between 300 and 900, with higher values considered to be positive.
You can say that this score points to the creditworthiness of an individual. It is often derived from a credit report, which special institutions create based on an individual’s credit banking or financial performance.
How Credit Scores Work
Every individual who uses a banking or financial system gets a credit score against their profile.
Special institutions analyse records of one’s income, tax, personal and business payments, and past or existing debts to create a credit score.
This scoring system aims to tell lenders whether offering a loan to an individual is a good idea.
Sometimes, loan institutions may not use your credit score to make an absolute decision such as whether to offer you a loan or not. They may rather use it to judge your capacity to refund a lesser loan amount.
For example, let’s say you apply for a loan of NGN 200,000.
If your credit score at the time is low, chances are you won’t be getting any loans. That’s it. Most institutions would have a single look at your credit score and conclude on rejecting your application.
However, a few other lenders may offer less than what you requested. Seeing that your credit score is not up to average, they may present a loan offer below NGN 100,000.
This might not meet your needs, but it represents an amount which the lender believes you can effortlessly repay.
How to Check Your Credit Score: Relevant Credit Scoring Companies In Nigeria
Individuals can employ the services of a credit bureau - just like loan institutions and businesses. More importantly, by Nigerian law, each citizen is entitled to one free credit report yearly.
Here’s a list of some credit-scoring companies in Nigeria:
CRC Credit Bureau:
CRC Credit Bureau was established to create and operate a consumer and corporate Credit Bureau in Nigeria.
The Credit Reporting Company manages pre-qualification, credit assessment, monitoring, and debt collection. It works closely with lenders and credit grantors to provide holistic and unbiased information to relevant stakeholders.
Credit Registry:
Credit Registry is another company licensed to operate credit reporting and scoring services within Nigeria.
The company reportedly applies big data solutions, credit scoring, and predictive analysis models. It serves individual consumers, businesses, and lenders.
Factors that Impact Your Credit Score
Here are a list of factors that can impact your credit score:
Loan Repayment History:
Your behaviour towards past loan agreements matters. Lenders use this to understand how collaborative you may be with a future loan. The factors considered here are subtle but important. They include:
**Frequency of your lump-sum repayments**:
Lump-sum payments refer to payments that are made in full and at once.
Let’s say you took a loan last month and the entire repayment amount is NGN 100,000. In addition, the loan agreement allows you to pay NGN 20,000 every month for the next five months.
Making a lump-sum payment will mean repaying the entire NGN 100,000 at once rather than in instalments. This action will help boost your credit score.
**Frequency of your on-time repayments**:
On-time payments culminate in an advantage for the borrower. They are seen as a commitment to the loan agreement.
Number of Active Loans or Loan Accounts
Imagine that there are two borrowers, A and B. Borrower A has an active loan with Access Bank. On the other hand, Borrower B has an active loan with Access Bank, Guaranty Trust Bank, and First Bank.
If these two individuals need some extra loan, it is Borrower A who will get more preference.
The idea behind this is quite simple.
Owning a number of loan accounts and in particular, having several active loans increases your financial burden. More loans will, therefore, mean having a lot of repayments to make.
This screams risk to lenders who will respond by rejecting Borrower B’s loan application.
Income Value
Before you can access certain loans, you will have to prove capable of making a repayment. Most often, this will depend on your engagement as a paid employer or employee.
You must have a source of income, preferably one that provides a regular salary or compensation. Lenders take this seriously. They believe that your ability to repay a loan increases when you’re meaningfully employed.
But earning an income is not the only focus here.
Loan institutions will often question the value of your income either monthly or annually. You see, it’s a difficult decision to offer a loan of NGN 1,000,000 to an individual earning less than NGN 100,000 monthly.
Nobody says that such an individual can’t make full repayment. However, the chances are incredibly low.
Transaction Volume
Large inbound and outbound transactions are good for your credit score. It is interpreted to mean that you are actively making money.
Some loan institutions will take your transaction volume at face value. On the contrary, certain lenders will dig into the details of each transaction. This helps them understand if your bank transactions really portray your financial standing or if they are unassociated with you.
For instance, if you are helping your sibling save money by holding it in your account. Those funds and all resulting transactions cannot be associated with you.
Ideally, this should not influence your credit score.
Proper Identification
When you apply for one loan or the other, you will be asked to submit your identity documents. In some cases, you will need to provide collateral.
These documents do not automatically make you eligible for a loan. However, they might help to boost your credit score and, therefore, position you to receive a loan in the future.
Simple Steps to Improving Your Credit Score
Credit risks are calculated based on a borrower’s capacity, collateral, covenants, and character. It is important that you perform remarkably well in each of these fields if you intend to access a loan.
A few things you can do to improve your credit score are:
Make On-time Loan Repayments:
Whatever your loan agreement is, you must ensure that you clear your debt before the set deadline.
Having an overdue loan does not help you and the lender.
In such cases, your credit score will take a hit. Moreover, other lenders and credit grantors will be immediately notified of your loan default, making it difficult for you to access new loans.
Making consistent on-time loan repayments is the best way to prevent this.
Avoid Fake/Fraudulent Transactions:
Passing funds through your account in the hope of boosting your transaction volume is wrong.
You should never be caught doing this.
In addition, accounts that are linked to fraudulent activities such as money laundering or terror financing, will attract very low credit scores. This should tell you to avoid fake and fraudulent transfers.
Clear All Open Debts:
An unclear debt temporarily reduces your credit score. This is true even in cases where the borrower is consistently making on-time payments and keeping to other terms in the agreement.
To avoid such, you must ensure you quickly clear all open debts and maintain good financial behaviour while doing so.
Provide Collateral
Collaterals make a statement that you are not going to run off leaving your debt unpaid. They significantly reduce a lender’s credit risk, giving them more room to grant your loan request.
Presenting collateral for every loan you take will definitely improve the way lenders and credit grantors see you.
Where Credit Scores May Apply Outside Loaning
Internationally, credit scores are not used by lenders and banks alone. They are also sometimes applied for:
Housing Accommodations:
Landlords may ask to access the credit score of a prospective tenant. They use the information to analyze the tenants’ financial situation. This then helps them determine whether to provide accommodation to a prospective tenant.
The idea here is the same as always.
Applicants with a low credit score are prone to default on their rent payments. If they have one or more bank loans unpaid, what makes you feel they will pay for rent?
Job Employments:
Employers always want to be careful about who they bring into their businesses. As a result, it is common to find them assessing the credit scores of prospective employees.
Someone with a bad credit history, huge debts, or a generally low credit score might not make a good fit. The reason? These individuals may be tempted to engage in fraudulent activities as a means of covering their debts.
Purchase of Merchandise:
Business deals involving thousands or millions of naira require a lot of trust. One way this trust value is determined is by analyzing the credit score of a business partner.
Like in the cases we looked at, people who have low credit scores might be in huge debt or have a bad financial record.
Being in business with such individuals might expose you to the risk of being defrauded. Alternatively, you may be held liable for the debts or poor financial behaviour of a business partner or merchant.
Conclusion
Credit scores are important within the financial system. Your access to several kinds of services depends on this single metric.
One last thing. If you really want to build your credit score, performing well in terms of capacity, collateral, covenants, and character is non-negotiable.