Money & Management – The Two Aspects of Your Credit History
Last Updated : July 6, 2020, 11:23 a.m.
Broadly speaking, the pillars of your credit history are ‘Money’ and ‘Management’. Whether a credit history is good or bad will depend on how you have scored on these two. A good credit history is vital to ensure you get fresh credits in the future without any delay. So, whether you are servicing the debt or looking to apply for a loan or credit card in the future, this post can help you prepare better. Let’s get started.
Let’s Check Out Money First
Money here refers to the obvious – Loans and Credit Cards. In the financial language, the number of credit accounts is a part of your credit history. Nobody can say with certainty as to what is the ideal number of credit accounts. At the same time, having more credit accounts will also depend on your needs. There could be some who may not apply for loans and credit cards to meet their needs. But there could be some handling more than one debt. While computing the credit score, lenders assess it based on all such accounts. Secondly, what helps credit bureaus like CIBIL calculate your credit score is the money you owe to lenders via each of the lending products. The amount owed to lenders carries as much as 30% weightage to your credit score. You must not conceive with the point of weightage that your credit score will be good if you owe a lot. It’s wrong! Lenders will check the type of credit and the outstanding that is left to service. In case you have multiple credits with a greater proportion of unsecured loans and credit cards, it is elementary to pay the dues on time. Further, it is important to show restraint on your credit card purchases if other loans are also there in your portfolio. If you go the other way round, the credit score could dip drastically. Whereas, with more secured loans in the portfolio, the credit history will get better and better on paying dues on time.
Now Come to the Management Aspect
This is perhaps the more interesting of the two. If the management is done properly, it could reflect very well in your credit report. Proper management will see you pay all your dues on time, which will help maintain a good credit score. So, what management should you do to pay on time? Let’s check out below.
Say No to Unnecessary Expenses
When you start servicing the debt, you need to rejig your spending constantly so that enough is left by the time the loan or credit card payment due date comes. Firstly, you need to figure out what unnecessary expenses you are doing and stop doing the same.
Use Credit Cards with Discretion
Credit cards have made things, which looked impossible in the past, possible with their wide array of features and benefits. At the same time, many fail to use the card wisely and end up revolving the credit by paying the due partially. Yes, credit card providers give you the option to pay the minimum due, which accounts for around 5% of the outstanding balance in a billing cycle, and avoid paying late payment charges. But doing so and repeating it time and again will raise your credit balance enormously high if not controlled quickly. You may go for a debt settlement if you find it hard to pay all. With a debt settlement, you and your lender will agree to a certain amount. Once you pay the agreed amount, the lender will mark it as ‘Debt Settled’ in its monthly report to the credit bureau. This might not decrease your credit score but will raise a question mark over the approval of loans or credit cards you may apply in the future.
Ensure an Optimum Credit Utilization Ratio to Maintain a Good Credit History
A credit utilization ratio is arrived after adding the credit card outstanding balance and dividing the resultant sum by the credit limit offered to you. Ideally, the credit utilization ratio must not exceed 30%. In case you are offered a credit limit of INR 70,000 on your credit card, you keep the monthly utilization limit to INR 21,000. That does not mean you should spend all INR 21,000 every month. The spending limit should be based on what you earn. Ensure your credit card spends don’t constitute more than 10%-15% of your net monthly income. If you have any other credit besides that, that percentage should reduce further.
Don’t Apply for Loans Frequently to Ensure a Good Credit History
Applying for loans frequently can make credit bureaus perceive you as credit-hungry. Such perceptions could lead to a reduction in the credit score. So, you should try and have a reasonably long gap between the credits. Also important is to ensure you don’t have to take loans frequently. For that to happen, you must save from your daily routine and put it to products according to your investment behaviour. If you have a low-risk appetite, spread your savings across savings bank accounts, recurring deposit, and a few in debt mutual funds too. Individuals with a high-risk appetite should mostly invest in equity mutual funds, with some in savings accounts too. If you maintain a good saving and investment plan, you may not require loans frequently, and there lies your chance of maintaining a good credit score.
Think About Debt Refinancing at the Right Time
Things don’t remain the same all the time. And that’s why you need to be flexible towards your repayment. You can thus think about doing balance transfer and prepayment at the right time to reduce the debt burden and ensure timely payments. The benefit of doing all these will reflect in your credit score. Let’s check out how these two can help you do so.
Balance Transfer
A balance transfer, as the name suggests, is a tool by which you can transfer the outstanding loan balance to another lender at a lower interest rate. With this, you can get the equated monthly installment (EMI) and interest reduced. You can reduce the interest further by opting for the same EMI. The loan will be paid faster with the same. Particularly, for a home loan, you should adopt this strategy as that runs for as long as 30 years. In case you face job uncertainty late in your life cycle, having the home loan closed much before you had applied for it will not only boost your credit history but also relieve you from the hassles of being burdened with debts at the wrong time.
How Can Loan Prepayment Help You?
As told above, things can be challenging as you grow older in terms of income. Once you begin your credit life, you need to avoid doing unnecessary spending and also save regularly. Saving regularly can help you repay on time, while also creating possibilities for wrapping up the loan before the scheduled closing date. In case you are paying a 20-year home loan, you can get it shortened to 15 years by saving from your daily routine and making it big over time. A windfall of money in the form of a bonus can only increase your savings further. The best part is that there are no prepayment charges, much unlike other loans. Prepayment can be done either in full or in parts. With a full prepayment, the loan comes to an end. With a part prepayment, a chunk of the outstanding loan balance is paid to the lender. The outstanding balance will reduce and so will the EMI and interest outgo. But if you want to pay off the loan quickly after part payment, keep the same EMI. This will not only reduce the tenure but also decrease the interest liability further. So, with the loan getting paid off in full before the scheduled closure, you create scope for further credits before you retire and meet your needs that may arise.