DYK: Your credit card usage can improve your credit score

If you already have credit history, you could use a credit card to improve your score

It is commonly believed that our credit score gets affected only when we default on a loan. However, often, an application for a loan or credit card gets rejected even though one has never taken a loan. This happens because lenders prefer to loan money to people who have a credit history. Here’s a look at how a credit card could help in strengthening a credit score.

What is a credit information report (CIR)?

The report contains details of your payments history pertaining to loans and credit cards, collated by a credit information company (CIC). In India, there are four such CICs—Credit Information Bureau Ltd (Cibil), Equifax Credit Information Services Pvt. Ltd, Experian Credit Information Co. of India Pvt. Ltd and CRIF High Mark Credit Information Services Pvt. Ltd.

The reports are submitted to them by banks and other lenders, on a monthly basis. The information is used to create CIRs and credit scores, which are provided to lenders to evaluate loan applications.

Credit scores range between 300 and 900, and a score above 750 is considered ‘prime’ to offer a loan to.

How a credit card can improve your score

When a lender gets an application for any kind of a loan (personal, auto, home or a credit card), it looks at the applicant’s credit history. But there are people who do not have a credit history, say, a person who has just started working. A credit card can come in handy here. It may be difficult for such an individual to get a credit card. While she might get one from the bank where she has a salary account after 3-4 months of employment, it will be easier to get a secured card (credit card against a fixed deposit) to create an initial footprint of credit. A CIC will only be able to score you once you have a repayment track of over six months reported.

Also, make sure you don’t make frequent loan inquiries or applications. If your application for a loan gets rejected, let some time pass (5-6 months) before making another inquiry.

If you already have credit history, you could use a credit card to improve your score. Maintain a low utilisation ratio and avoid defaults on credit card payments. Credit utilisation is how much credit you use versus the available credit limit. A higher utilisation indicates high leverage and high probability of defaults.

Defaulting on loan repayments hurts your credit score. So, regularise payments to build credit.

A settlement on a defaulted loan is also marked as a negative on your CIR. Go for a full and final closure instead.

Once the score is affected, it takes 9-12 months of good credit track record to build it up again. During this period, avoid missing credit card payments, high utilisation and inquiries for further credit.