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Explained: What affects your credit score

Applying for a loan at too many places or frequently maxing out credit card affects your credit score.

March 21, 2022 / 08:22 AM IST

Actress Sunny Leone recently took to social media to disclose that an unpaid loan of Rs 2,000 was erroneously reflected in her credit report. This minuscule unpaid loan amount affected her credit score; a number ranging between 300 and 900 given to an individual based on their repayment history.

Leonne claims she did not borrow this money, yet the loan was fraudulently attributed to her. Such incidents of fraud can impact your credit score. “Identity theft and credit report errors can affect the credit score of an individual. The liability of repaying such fraudulent loans rests on the individual under whose name the loan reflects and failing to make payments can affect his/her credit score, even under fraud,” says Arun Ramamurthy, mentor of credit helpline AskCred.

Such errors can creep into your credit report—maintained by one of the four credit bureaus in India—due to incorrect reporting by a bank or a financial institution, especially when someone else's loans is tagged to another individual's credit report and can hamper the credit score.

A weak score affects your ability to borrow money or get a credit card from a bank. A survey by Godrej Housing Finance titled ‘Post Generation Rent’ revealed that one in two women in India are now leaning towards asset building and purchasing property. To get the high loans for such purposes, a clean credit report is a prerequisite.

Credit scores and loans

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The credit score has a bearing on the interest rate that you are charged. “Applying for property loans invites lenders to investigate your credit history. If there is a problem in your credit history, your application may get rejected or you might be offered loans at a higher rate,” says Aman Gupta, director of RPS Group, a real estate services firm.

If your credit score is 750 or more, lenders offer the best loan rates. “If your CIBIL score is more than 700, you can get a home loan of Rs 2 crores at about 6.7 percent interest, which of course can shoot up to 7.5 per cent if your CIBIL score is less than 600. You will save about Rs 24 lakh over a typical term of 20 years if your credit score is a top-notch play,” Gupta says.

A customer’s CIBIL score is assigned by one of the four credit information company TransUnion CIBIL.

It is not just an unpaid loan, there are several other factors that weigh on your credit score. Surprisingly, even non-financial steps can have an effect.

Also read: Never had a loan or credit card? Your credit score may still not look great

Applying for loan at too many places

In their rush to source money, people often make multiple loan applications, thinking that if you knock at three doors maybe one will open. But this behaviour affects your credit score as you will be perceived to be in dire need for a loan.

But how would a bank or financial institution know that you have applied for loans with multiple entities? The moment you apply for a loan, a financial institution first checks your credit report and this is marked as a ‘view’ on your credit report. A high number of such ‘views’ or hits on your credit report indicates that you have sought many loans across financial institutions.

Unsecured loans

Another factor that affects your credit score is the ratio of unsecured loans in your overall debt. Credit card debt or personal loans are termed as unsecured loans as there is no asset to back the loan.

On the other hand, loans against assets such as fixed deposits, house, life insurance or other such instruments would indicate to the bank that you aren’t a spendthrift but an asset creator. So maintain a healthy mix of secured and unsecured loans.

Using your entire credit limit

If your credit card limit is Rs 1.5 lakh and nearly every month you are using up 100 percent of the credit limit on one or multiple cards or even overdraft limit, then your credit score could be impacted. Using up the entire credit limit time and again indicates your inability to handle money matters due to which your “credit utilisation” would be high and free credit limit on your card would be low.

Instead of using up 90 percent of your credit limit on one credit card, it makes sense to have three cards with 30 per cent credit limit consumed on each.  You would be using the same credit but since the free credit limit is high, your credit score is better.

Settlements

Sometimes, highly indebted people who have difficulty in repaying their loans or, worse, who have been defaulting on their equated monthly instalments try to settle their loan with their lenders. In simple words, this means that you pay off a lower amount and close the loan. However, this leaves a permanent stain on your record that could come back to haunt you later.

Settled loans may take the burden off your head, but it reflects in your credit score like a red flag. It tells your future lenders that you are prone to default. Banks do not want such borrowers.

Signing off as guarantor

Often, we stand as a loan guarantor when someone close to us borrows from a bank. We may not give it a thought because we think we are just helping out the person by making it easier for her to borrow. What we may not realise is that we are owning the responsibility of that loan.

“While standing as a guarantor for our friend or family member might seem rather harmless, it can have disastrous consequences if the individual defaults on the loan. Legally, a guarantor has as much responsibility to repay the loan as the individual who has taken the loan,” says Ramamurthy.

Repay existing loans, smartly and quickly

To enhance your credit score you should shorten your list of loans if you have too many of them.

You should get rid of the loans based on the interest you pay—pay off the loans with the highest interest rates first. But while trimming the list of loans, make sure you continue long-tenure loans such as home loans as these have a tremendous impact on your credit score. A long-term loan can help you build a history of repayment and tells the bank or financial institution that you are capable of handling credit.

Delay in corrections

Check for any mistakes in your credit reports and get them corrected promptly. Talk to your bank when you spot an error. Also, flag it to your credit bureau. But wait for a while to apply for a fresh loan as the corrections would reflect with a lag.

“Corrections on the credit report involve two processes—the reporting bank has to send an amended report to the bureau and in the second step, the bureau has to reflect this change in the report. While theoretically this process should take no more than 60 days, practically, the combination of the two steps could take three to four months,” says Ramamurthy.
Khyati Dharamsi
first published: Mar 21, 2022 08:22 am
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