It is important for an individual to build and maintain a good credit score. A good credit score helps them get credit cards and loans essential to fulfil important financial goals. However, there are several myths surrounding credit scores. Let us clear some of these myths.
While CIBIL is one of India's biggest credit information companies (CIC), it is not the only one. There are four credit information companies (CICs) registered with the RBI that operate in India. These are:
All the above four CICs maintain the credit history and credit score for individuals. You can check your credit score with any of the above CICs. As each company follows its own algorithm for calculating the credit score, the score of the same individual will vary with different CICs.
A good credit score is only one of the factors for approval of a credit score or loan. The other factors include:
Age: Your age should be between the minimum and maximum age bracket specified by the bank
Income eligibility: The bank specifies the minimum income eligibility for salaried, self-employed, and business persons for a credit card or loan.
Profession: If you are in a profession that is considered highly risky by the bank, it may reject your loan application. Some banks may blacklist some companies based on internal criteria. If you work for any of these companies, the bank will reject your loan application.
City of residence: Some banks, like HSBC Bank, American Express, Standard Chartered, etc., have operations in limited cities and cater to individuals residing in those cities. If you stay in any city outside of the specified list of cities, your credit application will be rejected.
KYC: If your KYC is incomplete due to some document or information that you have not submitted as requested by the bank, your credit application will be rejected.
Debt to income (DTI) ratio: It is the percentage of monthly income used to service debt obligations. If the applicant’s DTI ratio is above a specified percentage, the bank will reject the loan application. Most banks consider a DTI ratio of 35% or lower as a good ratio for giving a loan. However, some banks may consider a DTI ratio between 36% to 49%, with additional safeguards, to approve a credit application.
Thus, apart from the credit score, there is a combination of several factors the bank considers for approving a loan or credit card application.
An individual can build and maintain a good credit score only if they have a credit card or a loan. When you pay the credit card monthly bill or loan EMI, the bank reports the credit information to the CIC. Based on this credit information, the CIC calculates an individual’s credit score. So, without a credit card or a loan, there will be no credit score. Hence, to build and improve/maintain a credit score, having a credit card or a loan is a must.
You may have some old credit cards that you may not be using. You may be thinking of closing them. However, it is a myth that closing an old credit card helps improve the credit score. In fact, it is the opposite. Keeping old credit cards contributes towards improving your credit score.
Ageing of credit instruments (loans and credit cards) is one of the factors that contributes towards improving your credit score. So, if you have any old credit cards, transact with them occasionally for small amounts and keep them active. If an annual fee applies to those cards, check with the bank if they can be converted into lifetime-free cards.
The credit utilisation ratio is one of the factors CICs consider for calculating an individual’s credit score. The credit utilisation ratio measures the percentage of credit limit an individual uses from the overall credit limit available.
For example, Vijaya has a credit card with a limit of Rs. 5 lakhs. She used the credit card for Rs. 25,000 this month. Hence, Vijaya’s credit utilisation ratio is 5%. If the credit utilisation ratio is 30% or less, it contributes positively towards improving your credit score. If your credit utilisation ratio is more than 30%, it contributes towards bringing down your credit score even if you repay the entire monthly bill before or on time.
If your credit utilisation ratio is consistently above 30%, you should work towards bringing it down. Ask the bank to increase your credit limit on the credit card. With a higher credit limit and the same monthly usage, the credit utilisation ratio will decrease. If your income has increased recently, share the latest income documents with the bank and ask them to increase your credit limit.
Usually, banks consider a credit score of 750 and above as a good score for giving loans and credit cards. However, a credit score of less than 750 doesn’t make you ineligible for loans and credit cards. Some banks and NBFCs give loans to individuals with lower credit scores.
Some banks and NBFCs may ask for collateral and give a secured loan. You can even get a secured credit card against the security of a fixed deposit. Some banks may ask for a guarantor or a co-applicant to give a loan to an individual with a lower credit score.
Your annual income has no direct role to play in the calculation of your credit score. So, events like your annual income increasing, decreasing, or stopping have no direct impact on your credit score. If a person loses a job and their income stops, they may face difficulty paying the loan EMI and/or monthly credit card bill. Any defaults will decrease the credit score.
Using payment methods like debit cards, UPI on debit cards, internet banking, wallets, etc., has no impact on your credit score. When you use a debit card for a transaction, the bank doesn’t report the information to the CIC. It is only credit instruments like credit cards and loans that impact your credit score. When you pay the loan EMI or credit card monthly bill before or on time, it contributes towards improving your credit score.
Whenever you apply for a new credit card or a loan, the bank may do a hard inquiry of your credit profile. Such an inquiry may result in your credit score dropping by a few points. Other things being constant, the credit score will recover in a couple of months.
However, making too many loan and credit card applications in a short period will impact your credit score negatively. Hence, you should make one application at a time and wait for the bank to give their decision. You should maintain a sufficient time gap between two credit applications.
An individual checking their credit score any number of times doesn’t impact the score in any way. The credit score may be impacted when you make a credit application, and the bank assesses your credit report. So, you can check your credit score whenever you want. The score will neither increase nor decrease with your action. It is good to check your credit score regularly (maybe once a quarter) to track its progress and identify any errors, discrepancies, frauds, etc., and report it to the bank.
We have debunked some common myths about credit score in this article. It will help you build and maintain a good credit score. A good credit score is your gateway to credit products like loans and credit cards. Easy access to these credit products can help you fulfil important financial goals like buying your dream house with a home loan, enjoying a free family vacation with credit card reward points, etc.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
