A credit report is an important document. It is referred by financial institutions to judge your borrowing habits. Let’s talk facts, myths and a case study.
Additional Reading: How Credit Card Users Can Maintain A Healthy Credit Score
What exactly is your Credit Score?
A credit score is a numerical score which tells you how good or bad your credit track record is. This score is derived by taking into consideration a few factors such as your credit behaviour, repayment history, loan availed, type of loans, defaults, etc. The score ranges from 300 to 900. Generally a score of above 800 is considered excellent by the lenders and preferred for granting a loan or Credit Card to an individual. Even a 750 score will be considered good. Any score from 600-700 will signify that somewhere you have made mistakes and so lenders will be cautious. But if your score goes below 600, it’s a sign that you have not been disciplined enough to manage debt. This itself might lead to instant rejection of your application.
Okay, So What Really Affects Your Credit Score?
There is a lot of confusion regarding how your Credit Score gets affected due to various actions. There are a few factors, however, which are common. Here we go:
Default in EMI
An EMI default is not a good thing. It jumps out to a lender when they look at your report. Default in recent times will have a higher impact than an EMI default more than two years ago.
Multiple Queries
When you need credit urgently, you tend to apply for loans or Credit Cards across multiple lenders. Too many enquiries will reflect in your credit report negatively and lenders will be suspicious, especially when you are already repaying one.
Types Of Loans
The type of loans you avail is an important factor to determine your Credit Score. If you are heavy on high-interest unsecured loans like Credit Cards or Personal Loans, then it counts against you. But if you have a mix of secured loans like Home Loan and Car Loans, then the negative impact will be less.
Outstanding Credit
If your outstanding balance on Credit Cards or loans has been growing steadily, then it means your repayment burden is increasing, which after a stage, can impact your score.
Additional Reading: 6 Obvious Reasons To Check Your Credit Score Regularly
What Does Not Impact Your Score?
You’d like to know, wouldn’t you?
There is very limited information for the masses on the calculation of your Credit Score and that’s why a lot of myth surrounds it as well. We’ve cleared some of them for you:
Your Record
The fact that a credit bureau has your record does not mean that you’re a defaulter. Credit bureaus like Experian maintain a credit record, whether good or bad, of all individuals.
Many Credit Cards
What matters to a credit bureau is how you use them. Owning too many cards is not a bad thing. The utilisation of credit limits is what’s important.
Income
Your income has nothing to do with your Credit Score.
Age
Your age does not determine your Credit Score.
Additional Reading: The Credit Score Guide For 20-Somethings
Case Study
Prince started his career back in 2002 and got into the habit of utilising Credit Cards for all his needs. He had many of them along with Personal Loans. Prince also saw a lifestyle enhancement through credit. He had a lot of loans and kept changing his location due to career opportunities. Unfortunately, it led to a lot of default.
He was unaware of the consequences of his bad handling of credit till a loan was rejected in 2012. He accessed his Credit Score and was surprised to find that it was 540. This was very low and it showed clearly how much he had messed up his finances. Most of the defaults on his loans were of the time during his initial days. There was no recourse for him now but to improve it. He took advice from a friend who worked in finance and took some immediate action.
The first thing for him was to clear all outstanding dues on unsecured loans (Credit Cards and Personal Loans). So he proceeded to repay most of them. However due to limited resources, he settled some of them as the amount was a big ask for him.
Once he repaid his dues, he closed all of them.
He interacted with the banks and the credit bureau to ensure that all his payments were being updated. He continued with his Car Loan and Home Loan because he hadn’t defaulted on the EMIs. He repaid his entire Car Loan in the next year. He decided to utilise his Debit Card for his needs for the next few years.
He stopped applying for Credit Cards or loans.
For the next two years, his credit history did not show any transaction apart from the repayment of his Home Loan. One aspect which he managed very carefully was that he never defaulted on his secured loans. Gradually his score start improving. After a gap of two years, Prince accessed his credit report again. His score had risen to 750. A fairly good improvement but his friend advised that it would not still not translate to easy credit, which was true. His settlements were still visible in his report. Finally Prince was able to achieve the following from his friend’s advice:
- Disciplined Debt-Management
- Self-Awareness
- Differentiate between his needs and wants
Additional Reading: Check Out These Credit Score Success Stories
Much like Prince, many of us would have been in this situation. Although there are many institutions which promise to improve your credit record by charging a fee, you can improve it yourself, as demonstrated by Prince.
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