The first thing we learn as adults is the importance of maintaining sound financial health by following a budget, controlling debt, and establishing an emergency fund. One of the most common misconceptions that customers have is that debt of all kinds is bad. So, many people refrain from taking any credit, but there situations wherein credit can be useful.
Thanks to credit, it’s now possible to make big-ticket purchases, start a business, deal with a financial emergency, and then repay the amount later. Similarly, countless students avail education loans to pursue higher education and repay the amount over the years.
Their credit score and credit report determine the creditworthiness of an individual. A poor credit score can increase the chances of loan and credit card rejection. Thus, if you are planning to apply for a loan or take a credit card, how credit works must be absolutely clear in your mind.
There are many myths and misconceptions regarding credit scores that keep many credit applicants from getting official credit. Let’s first probe more about the concept of credit score and understand what good and bad credit scores are.
What is a Credit Score?
A credit score is a number that indicates the creditworthiness of a consumer based on their credit history. The credit score gives lenders an idea regarding one’s borrowing habits and the ability to pay off a loan or credit card debt.
By analyzing spending habits, payment patterns, and overall credit history, financial institutions, like banks and lending agencies, decide whether one qualifies for credit or not and the maximum limit for the same.
In India, most creditors consider the credit score allocated by one of the four major credit scoring agencies, namely CIBIL, Experian, Equifax, and CRIF High Mark. This three-digit score ranges between 300 and 900, and a score of 700 or above is generally considered good.
Top 5 Factors that Influence Your Credit Score
It is important to note that factors like marital status, age, race, nationality, salary, or occupation do not affect credit score. Also, contrary to popular belief, your participation in credit counselling programs does not hurt your credit score or report either. So now, let’s take a look at which factors actually influence your credit score:
- Payment History
Your credibility plays a vital role when lenders are trying to determine whether you can be trusted with a credit or not.
How you pay your debt, whether you make payments on time or not, how often do you make late payments, etc. are some of the factors that influence your credit score. Thus, it is critical to make timely EMI payments and installments in order to maintain a high credit score.
- Debt Level
Even if you are making timely payments, the overall debt you owe affects your credit score, as well. Lenders also take a look at your credit utilization ratio, which means they find out how much debt you have compared to your credit limit.
To maintain a good credit score, ensure your spending does not exceed 30% of the total credit that’s offered to you. Thus, you need to decide the amount of applied loan or credit card limit judiciously.
- Duration of Credit History
This is an essential factor that impacts your credit score because it helps keep track of your credit management habit. Keeping your older accounts open helps lenders see your credit repayment patterns.
And, if you have been making your payment on time, it will reflect in your credit score and garner benefits in the long run. Therefore, you must close all loan accounts on time and make sure that your credit report is up-to-date.
- Number of New Hard Inquiries
Each time you apply for credit, the creditor makes a hard inquiry to the credit scoring agencies. Although those with extensive credit history lose only minimal points with each inquiry, those with shorter credit history might end up losing a chunk. Furthermore, these inquiries can stay on your report for a period of over two years.
- Credit Mix
Borrowing different types of credit shows your experience at managing varied credit types effectively. So, a mix of credit cards, loans, and installment plans and how you keep up with them can influence a lender’s decision. A word of caution: apply for a new credit account only if you need more credit, and not just to diversify your credit mix.
What is Good and Bad Credit Score
Credit scoring agencies analyse your credit and financial history to determine your credit score. Based on the three-digit number you receive, your credit score can be considered good, bad, and average. Let’s discuss what constitutes a good and bad credit score:
Good credit scores
In India, a credit score is considered ‘good’ if it’s 700 or above, and you can achieve it by maintaining good credit habits. There are many benefits of achieving and maintaining a good credit score. For example, creditors usually offer customers with a high credit score lower rate of interest on loans and credit cards. For example, customers with high credit scores are generally offered a lower interest rate on loans and credit cards. Apart from this, such customers also enjoy benefits such as higher credit limit, the scope for negotiations, faster credit approval, etc.
Bad credit scores
A credit score is considered ‘bad’ if it falls under the category of 300-500. It can ruin your chances of getting your loan or credit card approved. If you have a credit score that falls in this range, you must take serious measures to improve it. Apart from frequent rejections from lenders, those with bad credit scores face several other issues; like a higher rate of interest, higher insurance premiums, and difficulty in starting a business.
Top 10 Credit Score Misconceptions and Facts
- Credit Scores Change Slowly
Credit scores change depending on your financial choices. So, whether your score is good or bad, it can vary according to the financial decisions you make today and in the future. Credit scores and reports are updated periodically to reflect your most recent economic and credit activity. Actions such as making late payments, skipping payments or defaulting on loans, can affect your score negatively.
On the other hand, if you show sensibility with your money, you can quickly improve your score as well. Over time, improving a low score is possible by exhibiting good credit behaviours rather than avoiding credit altogether.
- Getting Married Merges Credit Scores
If you have agreed to get married and are under the impression that your spouse’s good credit score will improve yours too, think again! As far as credit scoring agencies are concerned, you and your partner remain two individual entities with separate credit histories.
Unless you opt for joint accounts or take any financial decision jointly, the chances of your credit score getting affected are marginal. In cases like a mortgage, where the credit scores of both partners are checked, even if one of you doesn’t have a good score, it could be an issue.
- Debit Cards Build Credit Score
Regardless of how sensibly you handle your debit account, it is not going to impact your credit score at all. With debit cards, you use the money from your own bank account instead of borrowing it from a financial institution, like a bank or lender.
Moreover, the transactions made on a debit card are not reported to credit scoring agencies by the bank. So, whether you use your debit card to pay your phone bills or college fee, it won’t help you build or improve your credit score.
- No Debt Means Good Credit Score
While you do not have to go into debt to build a good credit score, not having any debt at all in your credit report won’t help either. Moneylenders check your credit history to ascertain how well you manage your finances, and having a zero score would not help.
To create good credit health without going into debt, ensure you use at least one credit method but use it wisely, and make timely payments. Let your account age and become a credible source to improve your credit score.
- Bad Credit Score Equals Rejection
A bad credit score does not close all avenues for all your future credit needs. Your credit score is calculated based on the pattern of your repayment and credit history and helps lenders evaluate your payback credibility.
While you can still get a credit card or loan with a bad score, but it might come with more terms and conditions. Although getting approval will be tougher, you can get through by paying a higher rate of interest or making a higher security deposit.
- Checking Your Score Affects Credit
Many people believe that checking their scores regularly could lower it. However, there is no truth to this as checking your score is not considered a hard inquiry, which means it does not affect your score at all. In fact, checking your score regularly helps you detect any erroneous information. All incorrect information and transactions must be reported to the respective scoring agency for rectification.
- A Better Job Means Better Score
A higher salary might indicate a better ability to pay off debts, but your salary or job profile has nothing to do with your credit score. Lenders do consider your income when giving loans, but how much you earn does not affect your credit score, which is primarily determined by your repayment habits. Low debt and high income will naturally improve your creditworthiness, which means you can be eligible for a lower interest rate.
- Paying Debt Instantly Improves Credit Score
If you have been making timely payments, you’d want your past debts to show up on your credit history, as this will help create trust with the lender. If, on the other hand, you’ve been chronically late with payments, it could create a barrier to getting loans.
As mentioned previously, long credit history can work in your favour, provided that you have managed it with prudence. Thus, even if you have just cleared a high loan amount, you need to follow it up with healthy credit practices to improve your credit score over time.
How to Improve Your Credit Score
If you have a low credit score, you must prioritize improving it, especially if you’re planning to apply for a loan or make a significant purchase, such as a new car or home. From a few weeks to several months, it could take any amount of time before you start seeing a noticeable change in your score. However, the sooner you begin to work on improving your score, the quicker you see progress. Here are a few ways in which you can increase a low credit score:
- Pay Your Bills on Time
First and foremost, fix your habit of delaying the payment of your bills. Your loan EMIs and credit card bills must be paid on time without any delay, or else such patterns would show up on your credit report. Also, avoid making late payments; you can install apps, set reminders, or opt for auto-transfer options to ensure that you never miss a single payment.
- Pay Off Existing Debt
You must pay off their debt timely and reduce the overall amount of debt you owe as soon as possible. The more debt you pay, the more way you make for new credit, which you might need in the future. Start by making a minimum payment on each account and then go on and set extra money aside to make higher payments.
- Apply for New Credit Only if Needed
Unnecessary credit applications can affect your credit score. Since every credit application or hard enquiry ends up on your credit report, showing excessive eagerness to live on credit can be detrimental to your credit health. What’s more, getting many approvals of credit can end up sabotaging your spending habits, as well. Thus, it would be best if you availed credit only when needed.
- Aim for 30% Credit Utilization
Credit utilization shows how much money you have borrowed out of the total credit that’s allowed. You must aim at maintaining your credit utilization below 30% at all times. Apart from making timely payments, consider making pre-payments in case you are using more than 30% of the total credit spending limit.
Credit scores are designed to evaluate whether a borrower will be a risk to money lenders or not. A low score hampers your credibility, and on the other hand, a higher score makes getting loans much easier. Credit scores and credit reports are necessary for times when you wish to apply for more credit, but they do not affect your personal credibility.
Having incorrect or incomplete knowledge about how credit scores are calculated could be keeping you from taking a mortgage for your dream home or falsely rely on debit cards to build a credit history. Know that while a higher income does not guarantee a higher credit score, you can use various other methods to boost your score.
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