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Avoid these assumptions that hurt your credit score

LiveMint logoLiveMint 18-04-2017 Sunita Abraham

If you have ever applied for a loan or sought any form of credit, you know that all credit seekers are not made equal. What differentiates you is your credit score. This score captures your credit worthiness into a single number, up to a maximum of 900. The higher the number, the better is your credit worthiness and easier it would be to access credit. While everybody is aware that it is important to keep the quantum of debt low and be regular in servicing the outstanding dues, there may be oversights and inadvertent errors in the way you manage your debt situation; which may be harming your credit profile. To keep your credit score healthy, don’t make these assumptions.

All is well with your credit report: Your credit score is calculated based on the information in your credit report. It is therefore important to periodically validate the accuracy of the information available in this report. Credit institutions provide details of your credit accounts, along with personal details such as name, address, contact details, PAN and income; which are used by the credit bureau to build your profile. If this information is incorrect or not updated, then the profile generated will be incorrect. It is important therefore to update changes in personal information to all credit institutions that you deal with. There may be oversights and inaccuracies on repayments and account balances being reported. Or, there may be enquiries, transactions and loan accounts added to your report that do not belong to you. All of these have the potential to pull down your credit score. You can avoid this by getting your credit report from the credit bureaus and reporting any disputed information to the credit institution for correction. The credit bureau will make the changes after the credit institution confirms the error and provides the correct information.

It is okay to hit the credit limit: Going all the way on using the credit limit sanctioned on credit cards, and other credit facilities, pushes up the credit-utilization ratio. This is the proportion of credit that you are using relative to what is available and a higher ratio is seen as indicative of risky financial behaviour. It raises concerns about your ability to service the debt and financial discipline. Similarly, closing (or lowering) of your credit lines will push up the credit utilization ratio, unless the reduction in available credit is matched with a reduction in credit used. Take a moment to consider the impact of any credit-related decision—such as applying for more credit, closing credit lines and increasing credit usage—on your credit utilization ratio. Any decision that will increase the obligations to pay, will have a negative impact on your credit score.

Some debt is good and others are bad for building credit history: It is important to have a diverse mix of credit types to improve your credit score. Strike a balance between secured longer-term loans such as mortgages and auto loans; and unsecured revolving loans such as credit cards and personal loans for the best reflection on your credit score. Credit institutions like to see how you handle different types of financing. For example, paying off a credit card balance in full instead of using the facility of revolving credit is seen as a positive.

A delay is okay as long as you pay it off: Delays in meeting your obligation and a patchy credit-servicing history will always reflect poorly on your credit score. The more recent the delay, the more frequent such delays and the more severe the delay, the greater will be the impact on your score. Delaying or defaulting making payments indicate financial indiscipline and inability to meet obligations. Have systems in place, such as auto payments, to make sure that you don’t inadvertently miss a payment.

Staying away from debt is the way to a good credit score: Staying away completely from all types of debt may not always be in the best interest of your financial situation. When you need debt in an emergency, or for an important goal, you may find that you are unable to access loans on favourable terms. Lenders look for evidence of responsible repayment behaviour before they lend, and not having credit history works against the borrower in such cases.

Closing old accounts will improve credit score: Don’t close out old accounts, such as credit cards, where you have a good repayment record. Longer-term accounts increase the average age of your credit history and that is positive for your credit score.

You can build a credit history in a hurry: Applying for multiple credit and loan facilities in a short period to establish credit history is more likely to backfire and negatively affect your credit score. Each time you make an application, the credit institution seeks your credit information and this enquiry can reflect negatively in the credit score. Too many applications in a short time may be seen as a possible stress on the available income from the repayment obligations, or that you are in financial difficulty and looking for debt to bail yourself out.

Debt repayment will immediately reflect in your credit report and credit score: You need to give adequate time for repayments and reduction in debt balances to reflect in the credit score. Typically, credit institutions take 30 to 60 days to report repayments to the credit bureaus. If you are banking on better loan terms from an improvement in the credit score, then give some time before you make a credit application.

If you have settled an outstanding debt, it is no longer in your records: Settling an overdue or disputed loan account may seem like a good idea to put an end to recovery calls and burgeoning interest costs. In a settlement, you pay less than what is due: typically the principal amount or an amount that is decided between the borrower and lender, and the remaining amount is written off by the lender. While this may eliminate an outstanding loan from your records, it will still show as a settled account against a paid-off account, where you pay the whole amount due. This information is available to prospective lenders and has a negative impact on your credit worthiness. If there is a dispute on the amount due, then it is a good idea to settle the dispute and pay off the agreed amount in full so that the account does not show as settled, but as paid-off.

Standing as a guarantor does not affect you directly: Standing guarantee for loans can be a double-edged sword for you. One, if the principal borrower defaults, then the repayment obligation transfers to you as the guarantor. And second, your ability to borrow may be constricted by the outstanding loans for which you have stood guarantee. Stand guarantee only for loans where you are sure of the ability and intention of the borrower to meet their obligations. And keep your own goals and need for funds in sight.

You pay dearly for a poor score and it takes a long time to correct it. Given that most people cannot avoid using some form of credit or loans, knowing the pitfalls and protecting the credit score should be a priority in a debt-management plan.

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