A good credit score is important. It can provide you with access to a wider range of credit facilities and help reduce the cost of credit. Going forward, your credit score may play an important role in non-financial matters, say employment or taking a house on rent.
Fair enough but what are the factors that impact your credit score? In this post, we look at 5 such factors.
#1 Missing Credit Card or Loan Payments
Nothing affects your credit score like defaulting on any of your credit card or loan payments. Even a delay of a day will have an adverse effect. The entire utility of credit score for the banks is to ascertain creditworthiness of applicants: to figure out whether the applicant will pay dues on time.
Hence, if you do not pay your card dues or loan dues on time, any credit score methodology will penalize you and reduce your credit score.
Even if you are acting as merely a guarantor on a loan, you are equally responsible for ensuring timely repayment of the loan. Hence, any late payment on that loan will show on your credit report and impact your credit score.
#2 If You Are Desperate for Credit
The more desperate you are for credit, the less the bank would want to lend to you. From a lender’s perspective, that’s a fair thought too. The banks also understand that taking credit is spending the money you don’t have. If you are desperate for credit, it means something is not right with your finances. And hence may not be comfortable lending to you.
A common joke is that the banks don’t lend to applicants who really need a loan. Jokes apart, how would a lender or a credit bureau assess such desperation?
If you are trying to take loans from multiple lenders, the banks/lenders will make a hard enquiry for your credit score/report from the credit bureau. This indicates that you are hungry for credit.
If the banks are not keen to lend to such borrowers, it is expected that the credit score for such borrowers reflects this. Hence, any credit score methodology would penalize such a behaviour.
#3 High Credit Utilization
If the utilization on your credit cards is high, that could go against you? Why?
Increased repayment burden. Higher credit utilization may also be an indicator of stress in your finances. Can be construed as credit hungry behaviour. But how high is HIGH?
Let’s say if your total credit card limit (across banks) Rs 5 lacs, what level of utilization would start going against you? Don’t think there is an objective answer to this. Each credit bureau might have a different threshold or might consider additional aspects while deciding those thresholds for individual borrowers.
I reproduce an extract from an article on Experian website for US retail customers:
While there’s no specific point when your utilization rate goes from good to bad, 30% is the point at which it starts to have a more pronounced negative effect on your credit score. As the data above illustrates, those with the highest scores tend to have credit utilization in the low single digits.
You might suggest that a way to reduce credit utilization is to increase your credit limit. By enhancing the credit limit within the existing card, or by applying for another credit card. Technically yes. But I am not sure if this will affect your credit score positively. After all, you are also seeking an additional credit limit which can be considered negative. Calculation of credit score is an interplay of multiple parameters.
#4 Getting the Credit Mix Right
While I do not understand this completely, a healthy mix between secured (home loan, auto loans) and unsecured loans (personal loans and credit card) has a positive effect on your credit score.
A good mix between different types of loan gives additional insights to the credit bureau about how (and if) you can manage different kinds of credit properly.
For instance, a home loan is a long duration loan and will have a fixed monthly installment. In contrast, with a credit card, you will borrow varying amounts every month and will have to repay within a short period. A personal loan is a short duration loan.
If you are able to manage all the above kinds of credit without any difficulty (or delays in payment), this tells the credit bureau that you are a good borrower.
Credit duration also matters. If you have been repaying different types of credit/loans on time for a long duration, it will affect your credit score positively.
#5 No Credit History Is Not a Good Credit History
This is a common misconception. Many people dislike credit and believe that their credit score must be good because they do not use credit.
Credit bureaus track your credit behaviour and accordingly assign you a credit score. However, if you just do not use credit, there won’t be any credit history. How can a credit bureau assign you a good credit score in that case?
That’s fair too. A credit bureau will look at data. When there is no data, there can’t be any assessment. And a credit bureau will have a way to reflect lack of credit history.
For instance, CIBIL uses a credit score of -1 to reflect insufficient credit history.
Have you checked your credit score recently? If you haven’t, do you know you can download 1 full credit report per calendar year from each of the credit bureaus, and that too absolutely free of cost? Don’t let this opportunity go to waste.
Download your credit report and check your credit score. If there are any errors in your report, raise a dispute with the credit bureau and try to resolve those. Alternatively, if your credit score is not satisfactory, take steps to improve the score.