Maintaining a high credit score through responsible behavior is an ongoing process
A strong credit score is the key to your financial health as it can give you access to the best offers on loans and credit cards. However, building or maintaining a high credit score through responsible behavior is an ongoing process. One must be aware of the ‘good and desirable’ actions that positively affect your credit score and stay away from the bad ones. Here are some common myths about credit scores:
Myth 1
Checking my credit score frequently will lower my score
When you apply for any type of loan or credit card, the lender obtains your credit report from the credit bureaus to assess your creditworthiness. This is commonly referred to as a ‘tough inquiry’. Too many tough inquiries from lenders within a short period can lower your score as it indicates credit appetite.
However, when you check your credit score yourself, it is known as a ‘soft inquiry’. Soft enquiry has no effect on your score. In fact, it is advisable to check your credit report every 2 or 3 months to track your credit score and take action to build it. Checking your credit score regularly can also help detect errors that may arise in your credit report.
Myth 2
My score will improve with increase in income
Your credit score is determined by your dealings with credit and is not related to income. Missing EMI repayment, high credit-utilization ratio, frequent and multiple applications for loans and cards can seriously damage your credit score, irrespective of your income. However, higher income affects your overall loan eligibility, as it signifies higher repayment capacity. Despite a strong credit score, low-income people may not be eligible for select credit cards or high-ticket loans.
Myth 3
Setting up a credit account helps improve credit score
Closing your loan or credit card account is different from closing your loan or card account. Closing an account means deactivation of a loan or credit card, with no outstanding balance, after full payment of the outstanding dues as per the schedule.
When one is unable to pay the outstanding amount for a period of time, the lender may choose to extend the option of settling the account through a lump sum payment option, where a certain amount of the loan can also be written off.
When you decide to settle your credit account, the credit bureaus are notified; It starts showing up on your credit report as a ‘settlement’ account. You need to know that this ‘settlement’ account stays on your credit report for a long time, and is likely to adversely affect all your future loan or credit card applications.
Since you missed payments as per schedule and settled the account, lenders will treat you as a ‘risky’ borrower in the future and may hesitate to approve your loan or credit card applications.
Myth 4
Banks will lend me as I have never taken any credit in the past
Many people believe that having no loans or credit cards makes it easier for them to get credit as they do not have any existing credit obligations to fulfill. this is not right. Having active credit accounts and displaying good repayment practices against them is a positive sign for lenders.
If you have performed well with your loan obligations in the past and continue to do so, your risk of default in future is relatively low and you can get loan approval at better offers and preferential rates. On the other hand, indiscipline in handling credit in the past makes you a risky customer and bureaus give you low credit scores which makes it difficult to get loans and cards.
But, if you have never taken any loan or credit card in your life, then you have no credit history. With no credit history, providers have no data to analyze the risk of credit being provided to credit applicants. Many large lenders avoid approving loan applications of such applicants. If you are new to credit, you also miss out on pre-approved loan and card offers from various lenders, apart from several benefits like preferential rates.
Myth 5
Closing Old Credit Cards Is Good for My Credit Score
We often close old credit cards to save on annual fees or simply because we don’t use them. However, this may not be appropriate if you do not have a long credit history, have not availed many credit products, or have a low credit score.
Before closing an old credit card, there are a few aspects to consider.
Firstly, it is always good to have a good mix of credit products in your portfolio as it reflects your ability to manage different types of credit. Therefore, before closing an old credit card, take a look at the total account in your credit report. If you haven’t had a lot of credit products, you may want to continue with the card for a stronger product mix.
Second, lenders look at the length of your credit history when you apply for any type of loan or credit card and here having a credit card with a long history and good repayment record can help. Therefore, if you do not have a very long credit history with other credit products, it is recommended to continue with the old credit card.
Also, remember that when you close a credit card, your credit limit will decrease, which can lead to a higher credit utilization ratio that will negatively affect your score.
(The author is Chief Product Officer, Paisabazaar.com)
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