Maintaining a strong credit score should be one of the most important financial goals for an individual. A good credit score would not only provide easy access to credit for financial goals, but also help you borrow during emergencies. Your credit score determines approval of your loan application as well as the pricing you will be offered on the loan. As this score is a numerical representation of one's credit behaviour, even small mistakes in one's credit life can have long-term financial consequences.
Your credit score determines approval of your loan application as well as the pricing you will be offered on the loan.
Here is a list of 6 common mistakes that you should avoid.
Many borrowers believe that missing payments of EMIs or credit card dues do not cause much harm as long as they are repaid later. However, as lenders avoid borrowers who have failed to meet their past loan repayment commitments, credit bureaus record those missed payments in your credit report and reduce your credit score.
What to do: Ensure timely repayments by the due date. If you have a tendency to forget repayment dates, set up standing instructions in your bank account to enable automatic repayments.
Having higher credit utilisation ratio
Credit bureaus use your credit utilisation ratio while calculating your credit score. This ratio is the proportion of your total credit card balances against the total credit limit available on all your credit cards. As lenders consider credit utilisation ratio of over 30-40% as a sign of credit hungriness, credit bureaus reduce your credit score on breaching this level regularly.
What to do: If you frequently use 30-40% of your credit limit, request your card issuer to increase your existing credit limit or get an additional credit card.
Too many credit applications in a short span
If you apply with multiple lenders to evaluate their products, each of those applications will be recorded in your credit report as hard enquiries and will be factored in while calculating your credit score. Credit bureaus consider multiple applications within a short span as a sign of credit hungriness and reduce the credit score.
What to do: Instead of directly applying with multiple lenders, use online marketplaces to compare loan and card offerings. Although, marketplaces too request your credit report to offer you the various credit products available, based on credit score and other criteria, these are considered as soft enquiries, and do not reduce your credit score.
Opting for credit card or loan settlement
Lenders often offer one-time settlement to borrowers having defaulted repayments for six consecutive months. Borrowers are lured to pay a lumpsum amount, usually higher than the principal amount, and rest of the outstanding is waived off.
As lenders consider credit utilisation ratio of over 30-40% as a sign of credit hungriness, credit bureaus reduce your credit score on breaching this level regularly.
However, lenders report such settlements to the credit bureaus, which then stay in your credit report for a significant period of time. As lenders refrain from lending to those who have defaulted in their past loan repayment commitments, credit bureaus reduce the credit score of such borrowers.
What to do: Ensure you get a "no-dues certificate" from the bank after settling your credit account. Follow up with your lender to convert the status of that account as "closed" instead of "settled".
Closing old credit accounts
Many close their old credit accounts or credit cards in the hope of improving their credit score. However, this may instead further reduce your credit score. First, closing old credit card(s) will decrease total available credit limit. This might increase your credit utilisation ratio, thereby forcing bureaus to reduce your credit score. Secondly, closing down a secured loan may increase the share of unsecured loans in your credit mix. As lenders prefer borrowers with a higher share of secured loans, an increase in the share of unsecured loans will lead to further reduction of your credit score.
What to do: Ensure you increase your credit limit or get additional credit card(s) before closing a redundant credit card. For loans, give preference to paying off unsecured ones like personal loans or loan against credit card before closing secured loans like home loans, car loans or loans against gold or securities.
Not reviewing credit reports regularly
As lenders use your credit report to evaluate your loan or credit card application, a clerical error on the part of the lender or bureau might adversely affect your credit approval in future. As of now, periodic checking of your credit report is the only way to detect such errors.
What to do: Use financial marketplaces to get your free credit report online at least once in three months. These will also get you pre-approved loan and credit card offers on your credit score.
The higher your credit score, the better is the possibility of getting a good credit card or a loan at favourable terms. Many of the mistakes listed above will reflect in your credit report for a long time, and may adversely impact your future loan and credit card applications.