Credit Score, the 3 digit number between 300 and 900 calculated by a credit bureau, is an important indicator of a person’s past credit behaviour including repayment history of prior loans and credit card dues. It helps lenders determine the risk involved in lending money to a loan/credit card applicant. However, there are various myths and misconceptions surrounding credit score that may prevent people from checking their own credit score or applying for a new loan/credit card, etc. The following sections discuss some such common myths and misconceptions in detail to debunk them.
1. Credit Score is The Sole Determinant of Your Ability to Secure Credit:
There is a common misconception that credit score is the only criteria determines your ability to secure new/additional credit. Though credit score is one of the first things that lenders look at when making lending decisions, it is not the only determinant. Lender’s own internal criteria along with several other factors like your debt to income ratio, employment and credit history, etc. are taken into consideration while lending money to a person. Thus, a high credit score does not necessarily guarantee approval and a low credit score does not always guarantee denial of a new loan or credit card application.
2. Checking Your Credit Report Hurts Your Credit Score:
Another common misconception is that checking your credit report or making credit report inquiries can negatively affect your credit score. In truth, inquiries made by banks and financial institutions for your credit report whenever you apply for fresh credit, known as hard inquiries, especially numerous hard inquiries within a short period of time can negatively impact your credit score as these indicate towards a probable increase in debt or may portray you as credit-hungry. However, a soft inquiry i.e. you checking your own credit report does not affect your credit score. Checking your own credit report regularly is in fact recommended so that you can know errors in your report, if any, and resolve credit report errors at the earliest.
3. Having a Credit Card Can Harm Your Credit Score:
Having a credit card would ultimately result in damaging one’s credit card debt is a popular misconception held by many. While it is true that repeated missing or defaults in credit card payments or maxing out your credit limit can affect your credit score adversely. Credit cards if handled responsibly are also one of the easiest means to establish and build your credit history and ultimately have a good credit score. The same holds true for a personal loan, home loan or car loan. You can build your credit history only by using credit in the form of loans and/or credit cards.
4. Closing a Credit Card Improves your Score:
No, closing a credit card account will not increase your credit score. Cancelling or closing your credit card account only brings down your available credit limit and pushes up your credit utilisation ratio. A high credit utilisation ratio (CUR) would in fact lead to a lower credit score. Instead, it is advisable to responsibly use your credit cards so that you maintain a CUR of 30% or lower.
5. Your Employer Can Check Your Credit Score:
It is often thought that employers in India can check one’s credit score to screen a potential employee just as in the US or the UK. However, in India, this is not common place and only with your permission can an employer check your credit report and credit score. In fact, such a credit report review is considered as a soft inquiry in contrast to a hard enquiry from potential lenders or credit card issuers. These hard inquiries could negatively affect one’s credit score if they signal that you are seeking multiple new loans/credit cards from various lenders simultaneously.
6. High Income and Good Job Profile Lead to High Credit Score:
Another common misconception about credit score is that a good income and job profile does necessarily lead to a good credit score. However, in reality, credit score is computed using the information found in the credit report like credit usage, management of credit, etc. The report does not include details of your salary slip or employment details. However, your employment situation and income does affect your ability to repay debts and may thereby, indirectly affect your credit score in the longer term.
7. Low Credit Score Lasts Forever:
People often believe that a low credit score will remain on their credit report forever. However, credit score only indicates the probability of defaulting on one’s repayments at a specific point of time. In other words, it indicates the risk involved in lending money to a person at a particular point of time. As a person starts changing his/her credit behaviour- starts repaying loans and EMIs in full and on time, the impact of past delays and defaults in payments on credit score decreases with time. Thus, credit score changes with time as new information is added to your bank and credit bureau files. And this updated and revised credit score is what lenders look at when evaluating loan applications.
8. Paying Off a Debt Means It is Cleared From Your Credit Report:
There is a common misconception that repaying your debt means it is cleared from your credit report. Though, repaying your debt does free you from the obligation to pay. It does not remove the evidence of debt from your credit report for several years. If you have made your debt repayments in full and on time, your credit report will indicate that you have utilized credit responsibly. Likewise, any missed payments or defaults in payments can put you in a negative light and may decrease your chances of securing additional credit in the future. As per TransUnion CIBIL, negative information like repeated missing or defaults in payments can stay on your CIBIL credit report for up to 7 years.
Thus, to build and maintain a healthy credit profile, a high credit score and to make responsible credit decisions, it is essential to have a clear understanding of key concepts of credit score. This way you will be able to make the best of your loans and credit cards and ensure availability of best offers on additional credit in the future.