One of the most important aspects of your financial life is your Credit Score. Your Credit Score is a three-digit number, built on the basis of how you have behaved with your past credit or simply put, how efficiently have you paid back your loans. This represents your ability to borrow money from institutionalised lenders like banks and NBFCs. Many people ignore their credit score, either due to lack of awareness or absence of any need to borrow money. What needs to be understood is that Credit Score needs to be built over time, to take care of your future borrowing needs. For example, a sudden medical emergency may force you to apply for a loan, but your Credit Score or the absence of it may stand in the way.
However, credit scores cannot be built without availing credit. Availing small loans to build credit history is not advisable as that would involve interest cost. The most cost-effective way to build credit history is to avail a credit card.
Why credit cards?
Using a credit card for making payments is equivalent to taking loans. Whenever you use your credit card for making payments, it is the card issuer that pays on your behalf. You pay it back when you settle your credit card bill. Hence, being a credit item, credit card transactions are reported to the credit bureaus who then include them in your credit report and use them for calculating your credit score.
Moreover, unlike loans, credit cards do not incur interest cost if bills are repaid by the due date. Although credit card issuers may charge joining and renewal fees, these are usually nominal and can be offset by managing your credit card transactions according to the interest-free period, reward point structures, cash-backs, discounts, annual fee waiver, etc.
As many credit card issuers offer credit cards to those without a credit history, start your credit journey by applying for a credit card with your existing banker. Additionally, visit online lending marketplaces to find credit card options available to you. Opt for a credit card that matches your spending behaviour.
Opt for a secured credit card if you fail to avail a regular one
If you fail to get a regular credit card due to insufficient income or residence in an un-serviceable location, opt for a secured credit card to build your credit history. These cards are issued against your fixed deposits (FD) and their credit limit is usually capped at 90% of the FD amount. Being lien marked, you cannot close these FDs until you surrender your credit card. If you default on repaying the credit card bills, the issuing bank can liquidate your FDs to recover the dues. These make secured credit cards a risk-free product for banks and hence, they usually do not evaluate eligibility criteria like credit score, income, and employment profile.
Other than the feature of using FDs as collaterals, secured credit cards are similar to regular credit cards. Like regular credit cards, secured credit card transactions are too reported to the credit bureaus and used for calculating your credit score. Other credit card benefits like interest-free period, fuel surcharge waiver, cash back offers, reward points, dining discounts, free movie tickets, EMI conversion, etc are also available on secured credit cards. Additionally, secured credit cards allow the cash withdrawal limit of up to 100% of the FD amount.
Once you receive your credit card, regular or secured, follow these tips to build your credit score.
Ensure bill payment by the due date
Lenders prefer to lend to those who consistently meet their credit repayment commitments by the due date. Bureaus too are widely believed to give maximum weightage to the debt repayment history while calculating credit scores. Any delay or default in credit card bill repayments are highlighted in the credit report and credit scores are reduced accordingly. Moreover, loan and credit card bill repayments continue to show in credit report for three years or more, which may hurt your loan eligibility for a considerable period of time. On the other hand, disciplined behavior in bill repayment will reflect positively in your credit report and steadily build your credit score too.
Contain your credit utilization ratio within 30-40%
This ratio is the proportion of your credit card limit availed by you. For instance, if your total credit limit is Rs 1 lakh and the total credit card transactions are Rs 20,000, then your credit utilization ratio will be 20%. As lenders prefer to lend to borrowers with credit utilization ratio of up to 30-40%, credit bureaus can reduce your score on breaching this level regularly. Hence, ask your card issuer to increase your credit limit or avail an additional credit card if you frequently breach this limit.
Avoid direct loan and credit card enquiries with lenders
Credit enquiries initiated by lenders on receiving your credit application are referred to as ‘hard enquiries’. Each hard enquiry is included in your credit report and your credit score is reduced by a few points. Instead, visit online lending marketplaces to compare various credit card options. Although these marketplaces also fetch your credit report from various bureaus, such requests are considered soft enquiries and do not impact your credit score.
<<This article was originally published in the Financial Express>>