Q. What is the significance of a credit score?
A. A credit score is a measure of how proficiently you handle your personal finances as well as how effectively you utilize borrowed funds. Therefore, if you intend to obtain credit from external sources, it is crucial to develop the skills necessary to manage and regulate your credit usage.
If you have a good credit score, your creditors have faith in your ability to repay the debt. Conversely, a poor credit score indicates that you may have delayed or missed payments on previous loans and pose a higher risk to lenders. Thus your credit management skills are reflected in your credit score.
Q. How long does it take to build your credit score?
A. Establishing a credit score can be relatively easy for individuals who have never defaulted on payments and have consistently repaid their loans. Conversely, individuals who have demonstrated poor repayments may find it challenging to build a good credit score. The time required to rebuild a damaged credit score varies but typically takes between six months to one year.
If your credit score is currently around 750 and you take the necessary steps to improve your score, you may observe a positive effect within six months and a higher score by year-end. Nonetheless, the amount of time needed to restore a credit score depends on individual circumstances. Therefore, it is advisable to take steps to enhance your credit score beforehand to ensure that you have a good score when you require credit. It is worth noting that lenders prefer applicants who already possess a very good credit score, preferably above 750.
Q. Why is it necessary to maintain a good credit score?
A. Having a high credit score is beneficial in many ways, including easier and quicker access to credit with better terms and lower interest rates. Maintaining a good credit score and managing your finances effectively can thus unlock numerous opportunities, such as owning a home or a vehicle, obtaining a loan and renting an apartment. A high credit score signals to lenders that you are a responsible borrower and have a low risk of defaulting on your debt. This, in turn, increases your bargaining power in terms of chances of getting approved for loans and credit cards with favorable terms, such as longer repayment periods, higher credit limits and lower interest rates and processing fees.
Q. What is a credit report?
A. A credit report is a comprehensive account of your financial background and any public records associated with your name. It discloses any credit-related occurrences tied to your identity. Your credit report also comprises of inquiries made by various external sources such as banks, financial institutions from which you intend to borrow regarding your creditworthiness. An algorithm processes all the data from your credit report to produce a numerical credit score.
Q. What are credit bureaus?
A. They are agencies that are responsible for gathering information about individuals to produce their credit report and score. Credit Bureaus gather and evaluate data related to the financial transactions made by individuals or businesses using credit, such as loans, credit card usage and overdraft facilities, as well as their repayments. This assessment may also incorporate information regarding factors like income taxes and the timely payment of utility bills. Data is obtained from multiple sources, including lending companies, data collection agencies and money collection agencies. The primary objective of this information collection and analysis is to establish a creditworthiness profile for individuals, which assesses their repayment patterns, default history and overall financial conduct.
There are four credit bureaus in India, namely:
TransUnion Credit Information Bureau (India) Limited or CIBIL
Equifax
Experian
CRIF High Mark
Q. How many credit reports can you get in a year?
A. Typically, you need to purchase your credit report and to do so online, you must provide your personal information such as your date of birth, Permanent Account Number (PAN) and email address. However, you can obtain one comprehensive report in electronic format for free, once a year, from each of the four credit bureaus mentioned above. Therefore, you can get four free credit reports in each year. This report will contain all of the same information that a bank would receive if you were applying for a new loan. Additionally, you can resort to a dispute resolution process to correct any inaccuracies that may be present in the report. The credit bureau websites provide access to these reports.
Q. What are the different types of debts that affect your credit score?
A. There are two types of debts that affect your credit score - secured and unsecured.
Secured debt is a loan that is backed by a collateral, which is typically an asset owned by the borrower, such as a home, car or other valuable property. Thus, home loans, car or auto loans and secured credit card loans are examples of secured debt. By securing the loan with a collateral, the lender can recover the amount owed by seizing and selling the asset if the borrower defaults on the loan. On the other hand, an unsecured debt is a debt which is not backed by collateral and is based solely on the borrower's creditworthiness and ability to repay the loan. Credit card debt and personal loans are examples of unsecured debt because the credit card company doesn't have any collateral or security that guarantees repayment in case of default.
Q. What factors determine a credit score?
A. The credit score is derived by considering the following factors:
1. Your payment history: It comprises of 35% of the total credit score. Payment history is indeed the most important factor in determining a credit score, as it indicates your ability to repay debts on time.
2. Your amount owed: It comprises of 30% of the credit score and it reflects your credit utilisation. It also indicates if you are taking on too much debt relative to your income.
3. Your credit inquiries: It contributes to 10% of your score. It tracks your credit activity including the accounts you already have and any new accounts that you apply for.
4. Length of your credit history: It contributes to 15% of your score. It provides lenders with more data over a long period to assess your payment behaviour. Generally lenders prefer to lend to borrowers who make regular and consistent repayments over a long period.
5. Your credit mix: It contributes to 10% of your score and tracks your credit mix of secured loans like home loans or car loans and unsecured loans like credit card loans.
Q. Why does payment history form the largest portion of your credit score?
A. The payment history section primarily focuses on your capacity to make timely payments towards your bills. Demonstrating a history of paying bills on time is perceived as a positive sign of your ability to repay bills in the future. Apart from your payment punctuality, the credit bureaus also evaluate the manner in which you pay your bills and the amount paid i.e., whether you pay in full or only the minimum required.
Q. What does credit utilisation mean?
A. Credit utilisation shows how you use all your credit such as credit cards, mortgage, car loans, etc. When calculating your credit score, both the utilization rate of each credit card you have and the average utilisation rate across all of your cards are taken into account. If you use credit cards, it's important to aim for an average utilisation rate below 30%. This shows that you are using your credit cards enough to build your credit history, but not excessively.
Ideally, you should aim to pay off your credit card balance in full every month and prioritise paying off larger purchases that push your utilisation over 30%. Once your balance exceeds 30% of your credit limit, it is reported to the credit bureaus at the statement date and high utilisation percentage may negatively impact your credit score.
Q. How can you lower your credit utilisation ratio?
A. Below are a few tips that can help you lower your credit utilisation ratio:
To maintain a low credit utilisation ratio, it's important to spend within your credit limit and adhere to the 30-70 rule. If you exceed the 30% limit on one credit card, you can balance it out with other cards by either refraining from using them until you pay off the outstanding balance or using them sparingly to bring the average utilisation below 30%. It's crucial to monitor your credit card balances every month and make full payments whenever possible. Even if you can't pay the entire outstanding balance, try to keep it as low as possible.
To further lower your credit utilisation ratio, consider keeping some credit cards with zero balances. This will increase your available credit limit and decrease your utilisation rate. However, it's important to calculate 25-30% of your total available credit and plan your spending accordingly.
If you've maintained a good standing credit card account for over six months, you may request a credit limit increase from your issuer to increase your total available credit and lower your utilisation rate.
Another useful trick to lower your credit utilisation is to contact your credit card provider and request a credit limit increase on one or multiple cards. This will effectively decrease your utilisation ratio because the amount you owe on your cards will become a smaller percentage of your total available credit. However, be mindful not to increase your spending. Also, keep in mind that some banks may perform a hard inquiry before granting the limit increase, which can temporarily lower your credit score. To avoid this, make sure to ask the bank about their policy before agreeing to the increase.
Q. What are credit inquiries? How do they affect your credit score?
A. When you apply for credit, the company you're applying to will request to access your credit report or credit score. This is applicable not only to credit cards but also to home, car and personal loans. Your credit score is viewed as a reflection of your character and reliability.
It's important to understand that when a company checks your credit with your permission, it sends a signal to credit reporting agencies that you may be seeking new credit or incurring new expenses that could potentially lead to debt. This is why credit inquiries can have a negative impact on your credit score for up to 12 months and stay on your credit report for two years. Although they account for only 10% of your score, limiting the number of credit inquiries can help you maintain good credit and gain points.
# PRO TIP:
When seeking a loan or credit card, avoid submitting applications to too many banks simultaneously, as doing so can result in increased number of credit inquiries and have a negative impact on your credit score. By minimising the number of accounts and expenses you have, you can reduce the potential for debt and improve your credit score.
Q. What are the different types of credit inquiries?
A. Credit inquiries come in two types: soft and hard, and it’s essential to distinguish between them since they have varying effects on your credit.
Soft inquiries, which are also called soft pulls, do not require your permission and do not affect your credit score. They only retrieve partial information to determine if you meet the basic approval guidelines of a company. Soft inquiries can result in prequalification, which is when credit card companies and lenders run a soft pull on you before sending you product offerings. Soft inquiries include quick credit checks by employers or unsolicited preapproval offers from credit card companies. You requesting your own credit report also counts as a soft inquiry. Thus you can check your own credit report as many times as you want without any impact on your score. This is because lenders understand that you are not trying to borrow money from yourself, but are only monitoring your credit history for personal reasons.
Hard inquiries, also known as hard pulls, differ from soft inquiries in several ways. Firstly, they require your explicit permission before being conducted. Secondly, they can affect your credit score and will appear on your credit report for up to two years. Finally, hard pulls usually provide a more thorough assessment of your creditworthiness and occur when a bank, credit union or car dealer runs a credit check on you after obtaining your permission. Multiple hard inquiries in a short period of time can indicate to lenders that you're trying to take on a lot of debt, which can be seen as a red flag.
Q. How can you protect your credit inquiries?
A. Here are some ways to protect your credit inquiries:
Ask about the type of inquiry required when applying for credit. Whether you apply online or in person, it's essential to find out if the application will trigger a hard inquiry.
Keep in mind that authorising a hard inquiry will likely lead to a temporary drop in your credit score. However, this doesn't mean you should never approve a hard inquiry. Just be mindful and avoid overusing them to prevent significant impacts on your score.
Avoid applying for too many credit cards within a short span of time. This is because each time you apply for a credit card, it triggers a hard inquiry on your credit report which can negatively impact your credit score.
Apply only for a credit card that fits your financial requirements and the one that aligns with your spending habits and offers rewards or benefits that you will actually use. Applying for credit cards that you don't need or won't use can lead to unnecessary fees and a lower credit score.
Check your credit score and credit report in advance to make sure you meet the eligibility requirements for the credit card you want to apply for. Knowing your credit score can also help you determine which credit cards you are more likely to be approved for.
# PRO TIPS:
When you're trying to choose a company or lender for a mortgage or car loan, you can have multiple hard inquiries within a short period without damaging your credit score. Even though each inquiry will be listed on your credit report, they will only count as one. This rule doesn't apply to credit cards and personal loans as multiple inquiries for these types of credit in a short time is viewed as a sign of desperation and could signal a higher risk of bankruptcy.
Consider applying for a prequalification before applying for a credit card. This can help you determine the likelihood of qualifying for credit without damaging your credit score. Prequalification is a soft inquiry on your credit report, which means that it won't negatively impact your credit score.
Q. What is meant by the length of credit history?
A. Your credit history length refers to how long you have been using credit, including your oldest and average open and closed accounts. Closed accounts also contribute to this section of your credit report, as it is more about age than performance. This is why folks with little or no credit history may be considered to have poor credit, as they have not had sufficient time to establish a track record of responsible credit use. Even if you have good credit, it may take more time to attain an excellent rating. To obtain a credit score, you must have a minimum of six months of credit history that is actively reported to the credit bureaus. If you have not used credit in a long time or have recently immigrated to the country, this can be a disadvantage when seeking credit as credit history from your previous home country may not be accessible and credit systems differ across countries.
Q. What is a credit mix?
A. A credit mix refers to the different types of credit accounts you possess, including mortgages, loans and credit cards. A credit mix is generally considered a crucial factor in calculating your credit score. Lenders and creditors typically prefer borrowers who have a diverse credit mix, indicating their ability to manage various credit accounts responsibly over an extended period of time.
Q. What are the types of credit accounts?
A. There are primarily two types of credit accounts - instalment credit and revolving credit.
Instalment Credit: An instalment credit is a type of loan that involves making regular payments, usually with added interest, over a predefined period of time. The payment amount remains constant throughout the term of the loan until it is fully repaid, after which the account is closed. An auto loan is an example of an instalment credit where monthly instalment payments are required until the loan balance is reduced to zero and the account is closed.
Revolving Credit: Revolving credit involves borrowing funds up to a predetermined credit limit and repaying the borrowed amount with interest, usually through a minimum payment while carrying a balance. Alternatively, the entire balance can be paid in full each month to avoid interest charges. After the debt is repaid, the borrowed amount becomes available for borrowing again. Credit cards are examples of revolving credit. When you make payments on your credit card, the borrowed amount is revolved and your credit limit becomes available to be used again.
Q. Which debt should you repay first?
A. You must pay at least the minimum due on all your debts. But it is advisable to prioritise making higher payments towards secured debts to avoid losing the collateral, especially if it involves your home or car. However, if you wish to avoid incurring additional interest charges, it may be wise to focus on paying off unsecured debts first, to minimise the overall cost in the long term.
Q. What are the ways to repay debt?
A. There are two ways to repay debt (secured and unsecured) namely, Snowball Method and Avalanche Method. The Snowball Method involves prioritising the repayment of debts from the smallest to the largest balance, regardless of the interest rates associated with each balance. The Avalanche Method involves prioritising the repayment of the debt with the highest interest rate first, regardless of its balance i.e. it aims to pay off the more expensive debt first. Although this approach may seem the most rational, it may not necessarily be the most optimal.
Q. How to repay debt using the Snowball Method?
A. Here are the steps to follow in order to repay a debt using the Snowball Method:
Create a list of all your debts in order from the smallest balance to the largest.
Determine how much money you can allocate from your budget towards paying off your debts.
Make minimum payments on all your debts, except for the smallest debt on your list.
Automate all your minimum payments to ensure they are made on time.
Allocate the money you've set aside for debt repayment, along with the minimum payment required, towards paying off the first debt on your list. Automate this payment to ensure it is made each month.
After paying off the first debt, apply all the money that was being used to pay off the first debt, in addition to its minimum payment, towards the next smallest debt on your list. Repeat this process until all debts are paid off.
To make the Snowball Method effective, ensure that the extra payments are applied towards reducing your principal balance. Credit cards usually apply the entire payment to the current month.
Q. How to repay debt using the Avalanche Method?
A. To apply the Avalanche Method, you need to:
List your debts based on their interest rates, from highest to lowest.
Then, you should make minimum payments on all debts except for the one with the highest interest rate, which should receive the maximum possible payment.
After this debt with the highest interest rate is fully paid off, you can move on to the next highest interest rate debt and apply the same strategy as the Snowball Method until all debts are repaid in full.
Q. What is a goodwill letter? How is it useful?
A. A goodwill letter is a request to a creditor or credit bureau to remove a negative item from your credit report, such as a late payment or delinquency. When asking for a goodwill adjustment, it's important to be polite, professional and honest in your communication with your lender or creditor. You can explain the circumstances that led to the late payment, such as a medical emergency or unexpected job loss and emphasise your past history of on-time payments and also provide any supporting documentation that may help your case.
However, it is important to note that goodwill adjustments are not guaranteed and are solely at the discretion of the creditor or lender. But if you have a strong relationship with your creditor and a solid repayment history, it's worth requesting a goodwill adjustment as it can potentially improve your credit score by removing a negative item from your credit report.
Additionally, it's important to continue practising good credit habits moving forward, such as paying bills on time and keeping credit utilisation low. A strong track record of responsible credit behaviour can increase the chances of a creditor or credit bureau granting your request for goodwill.
Q. How to make good any late payments you have made?
A. In case of a defaulted payment, you can do the following :
You can request for a goodwill adjustment as it can potentially improve your credit score by removing a negative item like a delayed payment from your credit report. This however would be the at discretion of the lender and would also depend on your past repayment record.
Automate your payments in order to ensure that you never miss a payment and avoid the negative impact it can have on your score.
Make a partial payment towards your outstanding balance. By doing this, you show that you are taking responsibility for the missed payment and are making an effort to catch up on your outstanding balance. It's important to note that making a partial payment may not always result in the removal of the late payment remark and it may still be reported on your credit report. However, it can potentially improve your relationship with your lender and show your willingness to resolve the issue and can also help you avoid any additional fees or penalties for late payments. However, ensure that the payment is credited towards the outstanding balance.
Pay off the complete outstanding balance in order to improve your credit score and have the late payment remark removed from your credit report. This shows your lender that you take your financial obligations seriously and are committed to resolving any outstanding debt.
Q. How long does it take for a defaulted payment to drop off from your credit report?
A. Late payments and other negative credit history items should automatically drop off your credit report after seven years. However, if you've defaulted on past loans or credit card obligations, it's crucial to make an effort to pay them off to improve your credit score. This can be done by discussing a repayment plan with your lender that aligns with your current financial situation.
Once you've fully repaid your loan, it's important to ensure that the updated status is reflected in your credit report. Administrative errors can sometimes lead to the old negative status remaining on your report, which can adversely affect your credit score. Therefore, it's important to check your credit report after paying off the loan to ensure that it accurately reflects the new, positive status.
Q. How can you dispute any errors in your credit report?
A. Your credit report is a proof of your creditworthiness and thus you must ensure that there are no errors that could potentially portray your positive credit information as negative. This requires you to review your credit report and verify the accuracy of the information listed. In case you notice any discrepancies in your credit report, you can file a dispute for their removal. To dispute any errors on your credit report, you should take the following steps:
• Provide a written explanation of what you believe is wrong with your credit report and why, along with copies of any documents that support your dispute.
• If you are mailing a dispute letter, make sure it includes your contact information, including your full name, address, and phone number.
• Clearly identify each mistake, such as an account number for any account you may be disputing.
• Explain why you are disputing the information.
• Request that the information be removed or corrected.
• Enclose a copy of the portion of your credit report that contains the disputed items and circle or highlight the disputed items. You should also include copies of any documents that support your position.
Q. How can you improve your credit score?
A. Refer to this post in knowise investor which is a comprehensive guide to improve your credit score:
Q. How to safeguard your credit score above 750?
A. Following are the ways to improve and safeguard your credit score:
Setting up automatic payments is a great way to ensure that you never miss a payment deadline again. It is a convenient and easy way to pay your bills on time and can save you from incurring late fees or negatively impacting your credit score.
Keep your credit utilisation low, as high utilisation can suggest you are reliant on credit and unable to manage your debt effectively.
Monitor your credit reports regularly and dispute any errors as it can to help ensure that your score accurately reflects your creditworthiness. In case you notice any inaccuracies in your credit report, it is important to contact both the credit bureau and the organisation that provided the erroneous information that appears on your report.
Additionally, keep old credit accounts open and avoid opening too many new accounts at once. Also try to maintain a diverse mix of credit as it can all help improve or maintain a high credit score.
Q. Does being a guarantor affect your credit score?
A. When an applicant's credit score is deemed unsatisfactory by a lender, they may require a guarantor. This means that the lender will only trust the borrower and advance the loan if he has a more trustworthy person paying on his behalf if he defaults the loan repayment. Thus the guarantor becomes responsible for paying off the debt alongside the borrower. If the borrower defaults on the loan, the guarantor is equally liable for repayment and may face legal action from the lender. Given this significant responsibility, it is not advisable to serve as a guarantor. If a lender is not willing to take a chance on the borrower, it is not wise to risk your financial reputation and creditworthiness for them. Instead if you really intend to help someone, consider other alternatives such as lending (without repayment expectation) or gifting the money to the borrower.
Q. When should you pay your credit card bill?
A. To determine the best time to pay off your credit card, do as follows:
Start by identifying your statement closing date, which is usually between 15 to 21 days before your payment due date. This date is crucial because it is the date when your billing statement is prepared and serves as proof of any debt you owe to the credit card company. You can locate this date on your bill or online account, or by contacting the credit card company directly.
The billing statement is also sent to the credit bureaus. If you want to boost your credit score, you can put your smallest recurring bill on your card and ensure that the balance is reported after the statement date to the credit bureaus. This will help you earn points for low utilisation and paying off your balance in full. On the other hand, if you have a high balance that is close to or exceeds 30% of your credit limit, it is best to pay it off or down before the statement date to avoid it being reported and potentially lowering your score. It is important to always pay off your credit card balance by the due date to avoid late fees and negative impacts on your credit score.
Q. When is it the right time to close a credit card?
A. To determine whether it is advisable to close a credit card, follow these steps:
• Create a list of all your credit cards.
• Total up the credit limits on each card.
• Add up the outstanding balances on each card.
• Calculate your credit utilisation rate by dividing your total balances by your total credit limits and multiplying the result by 100. For instance, if your balances equal ₹25,000 and your credit limits add up to ₹100,000, your credit utilisation rate is 25%.
• If your credit utilisation rate is between 20% and 30% or higher, you should not close any of your credit cards. Closing an account would increase your utilisation rate and lower your credit score.
• If your utilisation rate is below 20%, recalculate it after removing the card you wish to close.
After recalculating your credit utilisation rate without the card you want to close, if your new rate is still under 20%, then it's safe to close that card. However, if the new rate is above 30%, it's recommended to keep the card to avoid increasing your credit utilisation and potentially lowering your credit score.
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