Creditworthiness: Mind Your Credit Score

If you’re like most people, your credit score might be more of an enigma to you than anything else. After all, most of us go through our financial lives on autopilot, paying scant attention to how our personal credit related-habits are impacting our creditworthiness. As a result, many of us find ourselves in a sticky situation when faced with an urgent and immediate need for funds, as our credit scores just don’t stack up. And although a few new-age fintech lenders do utilise alternative data points such as income tax returns (ITR), mobile bills and utility bills to underwrite loans, these platforms typically offer only short-term personal loans of much lower amounts, and with steeper interest costs to boot. It follows, then, that consciously building a robust credit score is a crucial aspect of your personal finances. Here’s how to go about it.

What’s a Credit Score?
There are four main RBI-licensed credit bureaus in India that offer a credit score, which is really a “report card” of sorts. These are TransUnion CIBIL, Equifax, Experian and CRIF Highmark. Lenders share your credit history with these bureaus, who then spin out a monthly score on a scale of 300 to 900 basis their own internal grading mechanisms.

“A credit score of 750 shows that you have a good credit history, and banks and other financial institutions would be more likely to accept your loan and credit card application. On the contrary, a low credit score means you are a risky customer for lenders, and they will either reject your loan application or offer a higher rate of interest,” explains Radhika Binani, Chief Product Officer, Paisabazaar.com.

Moreover, having a good credit score will also bring down the cost of your loans, as you become a “preferred” customer for lenders. Hence, the importance of building a high credit score cannot be underestimated.

Start With a Credit Card
Credit cards may have been vilified as fuellers of consumerism-led spending binges, but their responsible usage is really the smartest and easiest way to carve out a good credit score over time. Unlike loans, credit cards do not incur interest cost as long as the bills are paid in full by the due date — in effect, giving you a moratorium period of a month where you can enjoy interest-free credit. So if you are a new-to-credit customer who doesn’t have a credit score yet, you should get in touch with your primary bank, and ask them for a credit card.

Here’s an interesting tip. Though curbing your card limits may enforce a certain degree of fiscal prudence, it could also hurt your credit score. As Binani explains: “Keep your card spends to around 30-40 per cent of your credit limit. If you breach this level regularly, your credit score may come down. Those with high credit utilisation ratio are considered as ‘credit hungry’ and hence, bureaus reduce their credit scores.”

In other words, you’re more likely to build an excellent score by having a credit card with a limit of Rs 100,000 but utilising only Rs 30,000 out of it, than by having a lower limit of Rs 50,000 and spending Rs 30,000 every month. Needless to say, make sure that you pay off your outstanding dues in full, a few days before your due date. While one or two late card payments may not impact your credit score significantly, making this a regular habit can drastically erode your credit score over time, even bringing you back to square one.

“A credit card is considered a simple product, and if one fails on the payment of a simple product, it implies that the person won’t be able to handle a complex product, which will crush the confidence of potential lenders,” warns Gaurav Anand, Co-founder, Namaste Credit.

Many = Good?
Two other factors that affect your credit score are your total number of loan accounts and their vintages. Put simply, a higher number of loan or credit card accounts, coupled with a responsible payment history, are considered a sign of a disciplined and good credit behaviour by lenders. But before you go about overextending yourself with a bunch of loans in an effort to max out your credit score, do bear in mind that this is akin to walking the razor’s edge – as you’re increasing your probability of default with every loan you take.

“Being able to manage multiple loan accounts with financial discipline presents the user as a matured financial individual. On the flip side, managing multiple loan accounts takes up a lot of time and effort,” says Anand.

You may consider owning no more than one Visa, one MasterCard, and one American Express Card to begin with, and spreading your monthly expenses between the three accounts.
Binani offers some important advice in this regard, with respect to loan prepayments. “While foreclosing loans, start with recent unsecured loans before touching long-standing credit facilities; especially those backed by collaterals, like home loans. This can increase the average age of your credit history and thereby augment your credit score,” she explains.

‘Hard’ versus ‘Soft’ Enquiries
Digging deeper into the finer points of building a great credit score, here’s another interesting fact you should know. When you’re out shopping for a loan, the nature of your enquiries gets reported back to bureaus too. Direct enquiries with lenders are considered as ‘hard’ enquiries, whereas enquiries on loan marketplaces are considered ‘soft’ enquiries. With each hard enquiry, your credit score falls a couple of notches, whereas soft enquiries do not impact your score materially. Think about that the next time you go berserk hunting for the best loan!

Binani cautions that this phenomenon tends to commonly play out with home loans. “While applying for a home loan, avoid making applications with multiple lenders within a short span, as this would deplete your credit score quickly and reduce your eligibility. Instead, visit online marketplaces to compare options basis your basis credit score, monthly income and other eligibility criteria,” she advises.

End Note
So, there you have it. The journey to a good credit score really involves keeping in mind a few simple pointers. Follow them diligently, and you’ll never have to worry about a declined loan application again!