Indians are traditionally brought up with the philosophy that all credit is bad and we should never seek credit unless absolutely necessary.
But without any credit line, you will have no credit score; which is a paramount yardstick for your financial health.
Credit scores come with so many associated myths. Here is a look at 6 such common credit score associated myths.
Closing cards will improve credit score: A common myth associated with a low credit score is that credit cards are the culprit. The fact is that closing a credit card may sometimes impact your credit score negatively as it increases your overall credit utilization rate.
Suppose you have 3 credit cards with a limit of Rs. 1 Lakh each and you spend Rs. 80,000 on an average each month from your cards collectively. With all 3 credit cards together your total limit amounts to Rs. 3 Lakhs.
Your credit utilization rate is therefore Rs. 80,000/Rs. 3 Lakhs * 100 =27%. Now, if you close one credit card, your total limit comes down to Rs. 2 Lakhs. And your credit utilization rate changes to 80,000/2 Lakhs *100=40%
So by closing 1 credit card you may seem more credit hungry than before, thereby reflecting poorly on your credit history.
You need to take loans to improve credit score: You don’t need to take loans to improve your credit score. In fact, if you applying for multiple loans, will actually hurt your credit score.
If your credit score is low or non-existent, you can try opting for a credit card. As you use the card and as long as you repay your dues on time, your credit score will eventually improve, allowing you to upgrade to a better card with a higher credit limit.
Your credit score will not change when you stand as guarantor: As a rule, if a debtor defaults, it is the guarantor’s responsibility to repay the entire loan. The guarantor will be considered not only as a defaulter, but his credit score will also be affected in case of non-repayment by the borrower. So if you are playing a good samaritan and standing as a guarantor for a loan for any friend or acquaintance, think twice.
As a golden rule, avoid standing as guarantor for any loan, unless you are sure of the person’s repayment credentials.
Credit score once spoiled cannot be retrieved: Just like Rome was not built in a day, you cannot hope to build a credit score overnight. This does not mean that you can never improve your credit score once it goes downwards. You will, however, need to maintain a strict financial discipline to slowly improve your credit score.
Taking some smart financial decisions, like making full payments on your credit card instead of just the minimum payment, can go a long way in helping you rebuild credit score.
Less loans means higher score: A common misconception is that no credit is equal to a good credit score. But how can your credit score be bad if you have never taken a loan?
Unfortunately it can be, as with no credit your credit rating is also zero or unknown.
So when you want to apply for a loan next, your application can be turned down as your credit score would be non-existent.
One default will wreck your score: Missing a single payment can affect your credit score, but it can be a temporary effect. It all depends on your bank and the type of default you have made. It also depends upon the norms of the rating agency.
For example, in case of the Credit Information Bureau of India Limited (CIBIL), payments delayed or missed for a period of less than 90 days are considered minor defaults. So, if your CIBIL score does take a negative hit because of a small single default, the effect can be temporary, allowing you time to catch up to the default.
Additional read:4 habits that can hurt your credit score
It is important to keep yourself aware of common myths associated with credit score to maintain a sound financial health.