Have you been turned down for a loan, and not just once, but multiple times? The majority of the time, the cause is your bad credit score. Your credit score indicates how you use credit and how creditworthy you are. Your capacity and desire to repay the loan is determined by your creditworthiness.
Credit bureaus like CIBIL, Experian, Equifax, HighMark, and others examine your credit behaviour and creditworthiness to provide a credit score ranging from 300 to 900. This is based on repayment information provided to credit bureaus by lenders.
Credit scores are used by lending organisations such as banks, non-banking financial companies (NBFCs), and housing finance companies to obtain insights into their customers, assess risks, and make successful credit choices
A credit score of 750 or above is generally considered acceptable. As a borrower or loan application, the higher the score, the better it shows your creditworthiness.
Let's look at some of the things that might affect your credit score:
1. Failure to pay outstanding debts on schedule - Missing payments or failing to pay your bills on time reflects poorly on your creditworthiness. If this is a regular occurrence, it will have a negative impact on your credit score (as it is reported as delinquency). This factor is given a particular weight by each rating agency, and repaying debts should not be treated lightly. Not only should you pay your loans on time, but you should also pay your credit card bills, energy bills, and any other outstanding debts. Paying past due bills on schedule is always in your best financial interests in the long run.
2. Multiple loan and credit card applications - When you apply for a loan from one or more lenders, it is recorded as a hard inquiry for a new line of credit, which might lower your credit score depending on how much additional credit you apply for and the type of the loan (secured or unsecured loan). Similarly, if you have been applying for several credit cards and have a spotty repayment history for the ones you already have, your credit score will suffer. Furthermore, you run the danger of falling into a credit card debt trap.
Keep in mind that asking for loans and credit cards at irregular intervals implies that you are frequently in need of money, which is a negative.
Maintain an ideal amount of debt (about 25-30% credit utilisation) and a fair balance of secured and unsecured loans (the credit mix).
3. Using credit cards or consumer loans to make large expenditures – Making large purchases on credit cards and using the full credit limit is OK as long as you have the financial capacity to pay off all of your debts on time. However, failing to pay your bills or paying only a portion of them adds to your debt load. The credit score is negatively impacted by revolving credit (high credit use).
As a result, make a conscious effort to maintain your credit utilisation below 30%.
Similarly, using consumer loans to buy high-value things on a regular basis should be avoided because it might hurt your credit score.
4. Reducing credit card limits and/or cancelling a card – The credit utilisation ratio (measured as the entire outstanding debt on the credit card divided by the total credit limit on the card) rises when you try to decrease your credit card limit. As a result, the credit score drops since more credit usage is not seen favourably by credit information businesses for rating purposes.
If your credit card limit was Rs 1 lakh and your outstanding dues were Rs 25,000, but you decided to reduce the credit card limit to Rs 60,000 (for whatever reason), your credit utilisation ratio will increase from 25% to 42% (beyond the ideal credit utilisation ratio of 30%) ––regardless of whether your credit is increasing in absolute terms.
Also, keep in mind that cancelling your credit card will have no beneficial impact on your credit score or improve your credit utilisation ratio. It simply truncates the credit utilisation and history, which is then used to calculate the credit score. Your credit score is frequently influenced by your credit age to the tune of 15%.
To prevent the negative consequences, rather than decreasing (or increasing) your credit card limit, use your credit card responsibly and pay your credit card bills on time. And, as much as feasible, resist cancelling the credit card if it does not charge outrageous annual fees and you receive a slew of incentives for using it.
5. Foreclosure of loans — While foreclosure of a loan might help you get out of debt, it can have a negative influence on your credit score, especially if it is a secured loan (home loan, car loan, etc.). This is due to the fact that it shortens your credit history and your credit account does not benefit the lender (in terms of interest). As a result, depending on the type of loan you have foreclosed and the source of funds for repayment, a lender may charge you a foreclosure fee. As a result, weigh the benefits and drawbacks before foreclosing on the loan.
6. Bankruptcy – God forbid, but if, due to your incapacity to repay loans, you have filed for bankruptcy—-a legal process—-and want to seek relief from your lender, your credit score will suffer as a result. Furthermore, you may be barred from future loan applications and compared to other bankrupt debtors.
7. Credit report error - Errors made by credit information firms while assigning credit scores might have a negative impact on your credit score. If you have a 'default' mark on a loan (secured or unsecured), but you are paying on time or have already paid it off, bring it to the attention of the credit bureau and/or the lender and address it.
If you've paid off a loan in full, don't forget to request a closure letter or No Due Certificate (NDC) from your lender, as well as a statement of account(s), any original papers you may have sent to the lender, and a lien release from your assets. All of this would serve as proof for you and assist you in improving your credit score in the future. If your lender has not notified the credit bureau that your loan account has been closed, you must do it yourself (by writing to them and submitting the requisite documents as proof). As a result, review your credit report once a month to ensure it is clear of errors and has no negative influence on your credit score.