LOAN WORTHY: Before deciding whether to sanction a loan or not lenders will always look at borrower’s credit score
Credit score works as the scale to determine the financial stability and credit management of a person. It is the number that lenders look at before giving money to a borrower. Whether a bank sanctions you a loan or not depends highly on your credit score. Following five factors are important to maintain a good credit score .
Payment history
A lender's main motive is to ensure repayment of the money loaned. This makes payment history, one of the most important factors in order to determine the credit score. Late repayment of credit card bills, loan EMIs, etc, lowers credit score significantly. The later the payment, the lower the credit score. Missing a repayment or paying off bills may reflect in your credit score for a long time. One of the effects of missing payments is that it keeps increasing for as long as a bill goes unpaid. So, a 30-day late payment will have a lesser effect as compared to a 60- or 90-day late payment. Affect of late payment depends on how much you owe.
In addition, creditors or lenders are likely to charge a late fee and even increase your interest rate after a few occurrences of late payments. Basically, you end up paying late payment fees for delaying or missing the payment as well as higher rates on later loans and credit lines.
Frequent on-time payments, thus actively reducing the amount owed, will diminish the bad effect on credit score over a period of time. However, sometimes a single derogatory mark on your credit, such as a bankruptcy, could have a major impact.
Credit usage
Credit usage is also a vital factor and it can quickly change to improve or hurt your credit health. The amount one owes based on loan EMIs — such as a personal loan, car loan, home loan or student loan, forms part of the equation.
Credit utilisation rate is the ratio between the total money that you owe and the overall credit limit on all the accounts (credit card limit). Lower utilisation of the credit limit helps in a better credit score. Utilising the maximum credit limit of the card or even surpassing it deteriorates the credit score significantly.
Generally, the overall utilisation affects the credit score. However, utilisation of individual accounts can also affect the score. Hence monitoring of utilisation rate of individual credit cards also becomes important. Multiple accounts or credit cards with a high utilisation rate make you a high-risk borrower. Early payments throughout the billing cycle provide a high available credit limit and low credit utilisation rate, thus helping in the improvement of credit score.
Length of credit history
It refers to how long you have been holding a credit account. Some factors that affect the length of credit history are the age of the oldest account, the age of the newest account, the average age of the accounts and recent use of an account. Opening many new accounts can lower your average age of accounts thus affecting the credit score. Closed accounts can stay on your credit score report for long increasing the average age of the accounts during that time. However, once these closed accounts are no longer in your report, it could lower the average age and affect your scores. If this happens to the oldest account then it significantly affects your credit score. An older credit age (or history) is better for the overall credit score as it shows the experience of handling credit accounts.
Credit mix and types
Mixing of various kinds of credit, such as credit cards, loan EMIs, etc, help to improve the credit score. Having a mix of credit indicates that the borrower has experience of the different types of credit. However, opening multiple accounts just for the sake of credit mix is not advisable as it affects on other grounds. Although credit mix constitutes for a low percentage of the credit score, it is better to have loans for different assets, like a car or home in addition to the credit card, a student or personal loan.
Not using a new credit card, defaulting on a loan, canceling a credit card or using a credit card too much can push the credit score down the hill.
New or recent credit
Opening multiple new accounts during a short span of time also affects the credit score. Multiple applications for new credit line leads to multiple inquiries or checks on your credit score thus raising suspicion in the mind of the lender. A soft inquiry like checking one's own credit score or eligibility for a credit card doesn't hamper the score too much. However, a hard inquiry affects the score, irrespective of the fact whether you got the loan/credit or not. An inquiry disappears from a credit score after two years.
Request for multiple new credit accounts raises suspicion on two fronts- borrower is in a crunch of cash flow or is going on a shopping spree, both of which are a big no-no for a lender.
CHECK CREDIT HEALTH
Payment history is an important to determine credit score. The later the repayment on your loan EMI, lower is your credit score
Credit utilisation rate is the ratio between the total money you owe and the overall credit limit (on all the accounts). Lower utilisation of the credit limit helps in a better credit score
The writer is founder and CEO, IndiaLends
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