Importance of Credit Rating for Getting Loans

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SME loans are the funding of small and medium sized enterprises. Since these small businesses augment the economic growth of the country, banks usually finance these companies or firms through various ways. There are ways in which banks lend money to these firms. The first is financial statement lending, in which banks give loans on the basis of the financial statements provided by the borrowing firm; the second is asset based lending, in which the bank estimates value of the various assets of the borrowing company, which generate cash flow and the third and the last one is credit scoring lending. In credit scoring lending, a quantitative model or tool is used to estimate the credit risks involve in giving an SME loan  to the firm. The attributes of the owner and the fiscal stability of the company are taken into consideration before giving a loan.

A credit score is a numerical figure depicting the credit rating of the loan applicant and it is calculated on the basis of a person’s credit history. Credit rating is when the lender estimates if the borrower will be able to fulfill his financial obligation and return the loan. It evaluates that whether the person is creditworthy to be given a loan i.e. what are the chances of him repaying the loan amount plus interest or failing on the EMI. This system is mainly used as a precaution so that the lender or bankers do not enter into bad debt and moreover also to know how much revenue a particular borrower will bring.

This factor comes into play especially when an individual applies for SME loans because the loan amount is huge, and since investing in businesses and start up enterprises are a bit risky.

Thus the credit score or the credit rating of an individual applying for loan is extremely important. The reasons for this are as follows:

Removes human prejudice

Since the process of credit rating is systematic and based on your credit history, the personal reasons of the lender do not play any role. If a person comes with verified and trusted credit history i.e. his credit score is reasonably high, the lender cannot refuse a loan.

Increases the chances of loan approval

If you come with a high credit score, the lenders or the banks are reassured that they are not entering into bad debt and that their loan will be repaid. Moreover, one cannot tamper with ones credit history, so banks consider it a reliable source of documentation and reference while considering a loan.

Accurate risk assumption

The number of credit cards under your name, your credit card usage, prior or current EMIs and the number of accounts you hold all affect your credit rating. The lender or the banks want to minimise their losses and cut down on the risk while giving you a loan. Thus, you credit history is an accurate reflection of your financial behavior. It shows whether you are a careful planner or a spend thrift.

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