Your credit score is an important indicator of your creditworthiness, ability to repay loans, and overall financial health. Your credit score can help you get loans like a home loan to buy your dream house, a car loan to buy the car you always eyed or a personal loan to enjoy a family vacation.
However, if the loans are not utilised properly and not repaid on time, it can put you in a debt trap and spoil your credit history. Similarly, if you don’t pay the credit card outstanding on time, the high finance charges and interest rates on credit cards can derail your financial planning journey.
Hence, you should be cautious of certain credit mistakes. What are these credit mistakes, and how can you avoid them? Let us discuss.
Applying for too many credit cards / personal loans at the same time: You should maintain the required time gap between two credit applications, whether applying for credit card(s) or loan(s). When you make too many credit applications too quickly, the bank or NBFC looks at it as credit-hungry behaviour on your part.
Hence, they may reject your credit card or loan applications. When you apply with a bank for a credit card or loan, you should wait for their decision. If the application is rejected for whatever reason, only then you should make the next application with the next bank or NBFC. Too many credit applications too quickly contribute towards impacting your credit score negatively.
Taking credit just to boost your credit score: If you are new to credit, there are two ways to get started with building your credit score. An individual can either take a loan or a credit card. If a loan is taken, there will be interest outgo even though the loan is being taken to start building or boosting the credit score. Hence, an individual may opt for a credit card if they want to start building or boosting their credit score. With a credit card, if the outstanding bill is paid before or on time, there will be no finance charges or interest charges.
If you are new to credit, the bank may not give you a credit card as the individual will not have a credit score. In such a case, the individual may go for a secured credit card. It can be obtained against the security of a fixed deposit.
Apart from helping you build or boost your credit score, credit cards can give you benefits like instant discounts, airport lounge access, reward points, and other benefits.
Missing / delaying the personal loan EMI or the monthly credit card bill: Once you take a personal loan or any loan, make sure you pay the EMIs on time. If you miss or delay any EMI, it will hit your credit score negatively. Also, you will have to pay a late payment fee to the bank. Similarly, the credit card monthly bill should be paid before or on time.
Paying the ‘minimum amount due’ for credit cards: When you receive your credit card bill, it will have the minimum amount due and the total bill amount. The minimum due amount is usually 5% of the total bill amount. Banks allow you to pay the minimum amount due and carry forward the remaining amount. However, you will have to pay the finance charges and interest charges on the amount carried forward.
Banks usually charge a 3.00% to 3.75% monthly (36% to 45% annually) interest rate on the balance carried forward. If the outstanding amount is high, the interest charges can put you into a debt trap. Hence, instead of paying the minimum amount due, you should pay the entire credit card outstanding before or on time to avoid the high interest charges.
Not checking your credit score / report regularly: You should check your credit score / report regularly, at least once a quarter. As per RBI guidelines, you can check your credit score free once in a calendar year from any of the Credit Information Companies (CICs) like CIBIL, etc. Apart from CICs, some banks and fintechs also allow you to check your credit score free of cost based on certain terms and conditions.
Checking your credit score regularly helps you keep a tab on the progress of your credit score and credit history. If you see any entries in your report that shouldn’t be there, you can report it to the bank and get it rectified.
Having a higher credit utilisation ratio: The credit utilisation ratio refers to the percentage of credit you use from the total available credit. For example, Diya has a credit card with a credit limit of Rs. 1 lakh. She used the credit card for Rs. 25,000 in the current billing cycle. So, Diya’s credit utilisation ratio is 25%.
If your credit utilisation ratio is 30% or less, it contributes positively towards increasing your credit score. On the other hand, if your credit utilisation ratio is higher than 30%, it contributes towards bringing down the credit score.
So, don’t make the mistake of thinking that if you use most or all of your credit limit every billing cycle, and repay the entire amount, your credit score will increase or stay the same. If your credit utilisation ratio is more than 30%, you should share your income documents with the bank and ask for an increase in the credit limit. With a higher credit limit and the same monthly expenses, the credit utilisation ratio will come down.
Becoming a guarantor for a loan without adequate due diligence: The bank treats a guarantor like a borrower for loan repayment and credit score. So, if the borrower defaults, you, as a guarantor, will be liable to pay the loan. It will also impact your credit score negatively and make it difficult for you to get a loan in future. Hence, before becoming a guarantor for a loan do a proper due diligence of the borrower.
We have discussed the credit mistakes that ‘new to credit’ individuals should avoid. Avoiding these mistakes will help you build and maintain a good credit score. A good credit score can help you get credit cards and loans on favourable terms. Credit card reward points can further help you accomplish your financial goals, like a free annual family vacation. A home loan can further help you achieve a bigger financial goal of buying a dream house.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
