To offer further respite to borrowers, the Reserve Bank of India (RBI) on 22 May extended the moratorium on repayment of term loans by three months till 31 August 2020. The central bank emphasized that the moratorium will have no adverse impact on the credit score of borrowers opting for the deferment of loan repayment. Since then, credit scores have become a topic of discussion, but there are a host of myths that surround them.
A credit score is a three-digit number that reflects the creditworthiness of a consumer. “Lenders use the score of an individual to understand the probability of the consumer being able to repay the loan before they approve or decline the loan application," said Ashish Singhal, managing director, Experian Credit Information Co, India, a credit bureau.
Factors such as total debt, repayment history, credit utilization, credit type and total credit accounts determine one’s credit score. Singhal said it is important for consumers to build their credit footprint to enable the banking system to evaluate their creditworthiness. “Many individuals end up with a poor credit history due to unawareness or lack of discipline," he said. Typically, a score above 720 is considered very good and anything under 300 is considered very poor.
Your credit score could be impacted by a multitude of factors such as customer product holding, repayment discipline, credit utilization, size of borrowing, type of loan, and length of credit history. It’s important to understand some of the myths that come with credit scores in order to make informed decisions.
INCOME IMPACTS CREDIT SCORES
No, income does not directly impact your credit score, but it does play a role in your loan and credit card eligibility. Income and salary are measurements that are considered for a consumer’s capacity to repay loans. “A consumer with high income but not disciplined in repayments of loans may have a lower credit score compared with a consumer with relatively lower income but more disciplined in making loan repayments," said Singhal. Adhil Shetty, CEO, Bankbazaar said credit scores reflect how much credit you utilise versus your total credit limit and how well you manage that credit. “Despite facing a loss of income in part or full, if you are able to pay your dues and EMIs on time, your credit score will not be affected."
NO LOAN MEANS GOOD CREDIT SCORE
Not true at all, because no loan means you do not have a credit history. Credit report analyses how you manage your credit and the absence of it means there is no way a lender can understand your financial behaviour. Therefore, borrowing could become challenging in the absence of a loan. “You could face challenges availing any line of credit if you do not have a credit history. The best practice is to build a credit footprint by ensuring timely repayment," said Singhal.
MULTIPLE LOANS MEANS LOWER CREDIT SCORE
There’s a thin line here because multiple loans could imply you are credit hungry and multiple credit inquiries can have a negative influence on your credit score. However, credit score is impacted by the ability to repay loans and not the number of loans. If you have multiple loans in your name but manages to repay them on time, you could have a higher credit score compared with someone with fewer loans but not a good repayment track record. “If your credit utilization is low and if you are able to make all repayments on time, then your credit score need not fall," said Shetty. Do keep in mind that multiple active loans could increase the burden, which could affect timely repayment.
MULTIPLE CREDIT CARDS MEANS BETTER CREDIT SCORE
Understand that too many credit cards means having a higher availability of credit and consequently lower utilization. For example, if you have six credit cards with a credit limit of ₹50,000 each, your total credit limit would be ₹3 lakh. If your average credit utilization is ₹1 lakh, then your utilization is 33% and Shetty said this is a good number. However, having multiple credit cards could mean multiple bills and multiple payment dates, increasing the chance of default. “The more cards you have to keep track of, the more likely you are to forget about a payment, which will affect your credit score. Only have as many cards as you can manage. Do not go overboard with it," said Wilfred Sigler, director – sales and marketing, CRIF High Mark. Singhal said having too many credit lines, even if they are not used, can hurt an individual’s credit score by making him appear risky to lenders.
REPAID DEBT WON’T REFLECT ON CREDIT REPORT
Note that credit reports track your credit behaviour for two-three years and therefore, all loans you held or closed during the time will show up on your credit report, and hence, impact your score. If there were delays in repaying your debt, it would reflect on your score. Sigler said all your accounts would appear on the report irrespective of whether it is paid in full or not.
EMI MORATORIUM WILL IMPACT CREDIT SCORE
In case you opt for the moratorium on term loans to deal with any liquidity crisis that you could be facing due to covid-19, know that it will not impact your credit score as long as the data is reported by your bank. However, Singhal said loans will continue to attract interest even during this period and your total indebtedness will go up, which could impact your eligibility to avail new loans. While it may not hamper your credit score, the reality is you may not be able to avail new loans. It is advisable to keep track of your credit report from time to time.
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