Credit cards can harm credit score the most

The credit score, which today plays a critical role in delivery of credit, has been affecting the achievement of financial objectives of individuals. Let us first understand a few basics on this.

The credit score stems out of details available on an individual's data with the credit bureau. All banks, non-banking financial companies and any other lending institution is required to share data of all their asset customers with bureaus. This is a mandatory requirement pronounced by the Reserve Bank of India. Lenders have to share all details on loans and credit cards regularly. These include the type of loan, amount, date of disbursal, current status along with the payment history. It means the credit bureau will at any point of time have historical performance on each credit facility for all individuals available with it.

Based on this historical performance, the bureau runs advance algorithms to predict the probability of an individual turning into a defaulter. The likelihood of non-payment is denoted through the credit score. In India, the score band runs from 300 to 900. A lower score denotes a higher probability of non-payment.

Now, what would any lending institution want from a borrower? To be responsible towards the credit facility extended to him and repay the instalments without any delay. In case the prospective borrower has had default in past, the lender would be skeptical about the future repayment. Depending upon the gravity of default, the lender may decide to either reject the loan request outright or may extend the same with some unfavorable terms. Let us understand this with following example.

A and B are your colleagues. Both approach you with a request for a short-term loan of Rs 5,000 and Rs 10,000 respectively. A had, in the past, taken Rs 3,000 from one of your other colleagues and had not returned it in time. On the other hand, B had also taken Rs 5,000 from another colleague and had repaid before the committed date. You may decide not to lend Rs 3,000 to A. On the contrary, you may decide to give only Rs 5,000 to B.

In above example, the past performance on repayment has influenced your decision. Had A paid back the money, you might have extended him the loan. As far B is concerned, you would be willing to take a risk of up to the amount that he had repaid without any issue.

The whole process of lending boils down to the credit profile, which is measured in terms of credit score. A good score will aid the underwriter with faith and trust in the borrower, while a low score will result in wariness.

It goes without saying, that trust is a fundamental requirement in life. We trust people, processes, and practices on a daily basis. People turn to individuals in whom they have confidence when they want to rely on something important. And this confidence is an outcome of trust that the person would have built over a period of time.

Similarly, the credit score is the aid that helps one build trust in the lender for all future credit facilities. Just as one's effort reflect on his capability and reliability at work, the responsibility of continued endeavor to build a good credit profile is a must. If not, it may impair one's chances of access to credit and leave one in a stressful situation when facing an exigency.

The writer is director & co-founder of Credit Sudhaar