Defaulting or making late payments on your loan and credit cards decreases your credit score is common knowledge. But did you know there are other little-known things that may hurt your score?
Your credit score is based on your credit report. Banks use the score to predict your repayment capacity and the likelihood of you defaulting over the next 12-month period. Today, we have two credit scores in the country. Credit Information Bureau (India) Ltd (Cibil), the first credit bureau to launch in India, launched its credit score in April. Equifax Credit Information Services Ltd launched its score, called “risk score”, in December.
Here are seven things you should watch out for if you want a healthy score.
Becoming a loan guarantor
At times, you can’t avoid becoming a loan guarantor; you can’t refuse family or friends for fear of straining relations. But even at that cost, it is advisable that you become a guarantor only if you are absolutely sure about the repayment capacity of the loan taker. This is because if the primary borrower defaults on his payments, it will affect your credit score negatively.
Says Arun Thukral, managing director, Cibil, “If the primary borrower defaults, his score will definitely be affected in a negative manner. Also the guarantor’s score is affected negatively, though not to the extent as the primary borrower.” After all, in case the primary borrower defaults, the legal onus of the debt falls on the guarantor.
Making too many loan enquiries in a short time
The number of enquiries you make for a loan is reflected on your credit report. So make sure you do so only when you actually need a loan. Says Samir Bhatia, managing director and chief executive officer, Equifax, “The number of enquiries also have an effect on the score. A large number of enquiries in a short duration will affect your score negatively.”
More enquiries on your account from new lenders shows that you are looking for credit and a large number of enquiries indicate you are getting credit-hungry and could shave a few points off your score.
Taking settlements on your credit cards
“Settling of accounts” is a term commonly used when the lender accepts a payment which is less than the total amount you owe on your card. For instance, if you owe Rs 1 lakh but you negotiate with the bank and settle the account for Rs 70,000. In this case, the remaining Rs 30,000 is written off as bad debt.
By not paying Rs 30,000 you compromise your credit score. Thukral says, “Settling an account decreases your credit score. Not only that, even future lenders will view this as negative.” Lenders are usually wary of borrowers, who have had settlements on their accounts.
Your credit utilization
Simply put, credit utilization means the amount of debt you utilize compared with the amount of credit limit you have. For instance, if you have a balance of Rs 90,000 on a credit card with a credit limit of Rs 1 lakh, it shows that your credit utilization is 90% on that card.
Thukral says, “Over-utilization of credit shows that you are always hungry for credit. If your credit utilization is always 95-100%, it shows you are always in need of credit. Maximized cards definitely hurt your credit score.” Also, crossing the credit limit of your card will have an adverse effect on your score.
So, what’s a good utilization amount? Thukral says, “Anything less than 40-50% is good enough; 30-40% of credit utilization is ideal.”
But this could vary from bureau to bureau. Bhatia says, “As long as you are regular on your bill payments and don’t default, a high credit utilization won’t harm. In fact, there are banks that may prefer borrowers with high credit utilization with a good repayment track record.” But if you continuously make only part payments and have high credit utilization, it will negatively affect your score, though marginally.
Also, each account is different. So if an account with a credit limit of Rs 5,000 and a balance of Rs 2,000 will be treated differently than an account with a credit limit of Rs 5 lakh and a balance of Rs 2 lakh.
The point we are making here is don’t go overboard on credit utilization and even if you do, never be late on payments or don’t default.
Mix of credit
The type of debts you have also affects your credit score. A report with a good credit score has a mix of different types of credit, including credit cards and loans. Thukral says, “A good mix of different types of loan accounts is seen as a positive for the credit score.” If you have only unsecured loans such as credit cards and personal loans and no secured loan, it will not help your score much.
Closing unused cards
There are two things you could do with cards that you do not use—you could either close them or continue to hold them unused. Usually closing of cards could trim your score. Bhatia says, “Closing of a card could marginally affect the score negatively, but it’s better to close unused cards to avoid any possible misuse.”
But there is another theory as far as this parameter goes. Thukral says, “The older the credit history, the better it’s for your credit report and hence score. The thicker the credit report, the better it is. If you have cards that you no longer use, your total credit utilization becomes lower.” For instance, suppose you have two cards with a credit limit of Rs 1 lakh each. Now on one card, you have a balance of Rs 1 lakh but the other is unused. Here, your total credit utilization would be 50%. But if you close the unused card, your credit utilization would go up to 100%.
Also, when you close unused cards, the history goes off the report after a few years. Thukral says, “A longer track record helps lenders predict your future repayment and default behaviour.”
We suggest that as far as loans go, it’s best to close them properly and ensure that they don’t show as active accounts on your report. As far as unused cards go, close them to avoid misuse. But if you are someone who has a weak score, first try and improve your history, build a stronger score and then close all the unused cards.
Some card members used the balance transfer facility to transfer debt from one card to the other. While this is a good debt management strategy, ensure you don’t get into the habit of balance transfers. Just doing a balance transfer won’t trim points on your score, but if you get into the habit of frequent balance transfers, you will have a large number of open credit lines. And more number of active accounts may marginally affect your score in a negative way.
Keep in mind that even as the country has two credit scores in place for the consumer, every bureau has a unique methodology to arrive at the score. Bureaus could use between 250-600 different variables to assess the score and have different weightage for the same parameters. So make sure you don’t leave out any gap that could affect your credit score.