A credit score is a statistically generated 3-digit number between 300 and 900 that summarises your past track record of debt instruments such as loans and credit cards. Banks and other financial institutions rely on credit scores, among other factors, to determine your creditworthiness for a future loan or a credit card. Even, the interest rates offered to you may be affected by your present credit score. In India, where your credit score can range from 300 to 900, any score below 750 is considered as a bad credit score. The lower your credit score, the higher the lender’s risk-perception regarding you as a borrower. Thus a bad credit score may lead to rejection of your loan/credit card application or result in higher interest rates. It is therefore very important to be aware of key factors that may lead to a bad credit score.
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The following are some of the leading factors that lead credit bureaus like CIBIL TransUnion, Equifax India and others to give you a bad credit score.
Frequent Defaults or Late Repayments of Debt
Your debt repayment history inclusive of loans and credit card dues constitutes around 30–35% of your total credit score. Each time you default in your debt repayment or pay the outstanding amount after the due date, your lender reports that default or late payment to the credit information bureaus, who in turn deduct points from your current credit score. The exact deduction amount from your credit score may be affected by factors such as the size of the outstanding loan/credit card bill, number of late payments in the past, number of days after which late payment was made etc. Moreover, this late payment information continues to feature on your credit report for a few years. Thus, make sure you stick to your repayment schedule and keep your repayment record as clean as possible. If you face any temporary problems in repaying your debt, contact your lender to work out favourable repayment terms.
High Credit Card Utilisation Rate
Credit card utilisation rate is an important indicator of lending risk and is used in most credit scoring processes. This rate depicts your average credit card balances against your available credit card limit across all your cards. Although an increase in credit card spending does not in itself lead to low credit score, an excessive usage of your credit limit shows that you are a credit hungry customer, who is unable to manage his finances properly. Ideally, your credit card dues should not be more than 30–40% of your total credit card limit across all cards.. For example, if your credit limit is Rs 60,000 on a card and you are planning to purchase an item worth Rs 30,000 your credit utilisation rate will shoot up to 50%. However, if you have a second card with a credit limit raised of, Rs 30,000, your utilisation rate will come down to about 33%, which is well within the 30% to 40% limit.
High percentage of unsecured loans
Secured loans, such as home and loan against property, are considered to be good loans as they are usually used for asset creation or income generation purposes. Timely repayment of these loans improves your credit score as it reflects your trait of judiciously using your available credit options. On the other hand, unsecured loans, such as credit cards and personal loan, are primarily used to fund personal consumption, hence, having too many of them reflect poorly on your credit behavior, leading to a bad credit score. Moreover, unsecured loans usually carry higher rate of interest than secured loans, which results in higher interest payout and therefore, negatively affect your ability to service fresh credit.
Too many credit enquiries
Each time you apply for a loan or a credit card, a credit enquiry is raised by the prospective lender, which is then recorded in your credit report and shows up whenever another prospective lender pulls your credit score. As these enquiries are dated on the credit report, too many credit enquiries within a short span of time depict you as a credit hungry person, who desperately needs money and hence, a potential credit risk. The credit bureau notes this in your credit report and accordingly lowers your credit score, which makes it harder for you to get approved for new loans or credit cards.
Lender’s failure to report your debt repayments
Often, banks and other lenders fail to intimate the credit bureau about your recent debt repayments. This may result in closed credit accounts being shown as active and previously paid credit card dues or EMIs shown as outstanding ones on your credit report. Thus, through no fault of your own, your credit report continues to show incorrect information, which then leads to a poor credit score. Therefore, it is important to check your credit report at regular intervals, at least annually, to ensure that all your repayments have been duly recorded in your credit report.
Opting for settlement instead of repaying your debts
Individuals who fail to repay their debts in full, are often lured into settling their dues through a one-time settlement with the lender. Although the borrower gets a steep discount on his/her total dues, the lender reports that settlement to the credit bureaus. On the credit report, such this type of debt would show up with a “settled” tag that severely impacts the individual’s credit score. Due to the bad credit score, the prospective borrower is perceived as a credit risk because of the borrower’s failure to repay his previous debts.
Default in accounts where you are a co-signee or a guarantor
In case of co-signed, guaranteed or jointly held loan accounts, you are equally liable for defaults made by the primary applicant. Thus, any default by the primary applicant will also show up on your credit report and bring down your credit score unless you make the due amount payments after the primary applicant has defaulted on the loan.