A credit score, typically ranging from 300 to 900, is a numerical indication of a person’s creditworthiness. Your credit score is a tool that banks and other financial organisations use to assess your creditworthiness and ability to make on-time loan repayments.
So, if you are looking to buy a new home, apply for a new credit card or buy the latest gadget on EMIs, it’s your credit score that will determine whether you are eligible for purchasing any of these products on a loan or not.
Credit scores are sometimes also used by certain organisations as part of their employment checks to understand the financial behaviour of an incoming employee. Now that we have understood the basics, let’s understand the importance of a good credit score and how to maintain it.
Why is your credit score so important?
A healthy credit score can open up multiple doors for you when it comes to credit products. A robust credit score is a financial asset and will open doors to numerous opportunities. As a gatekeeper criterion for lenders, your credit score significantly influences your eligibility for loans and showcases your financial discipline. A strong credit history and a consistent track record are the most important factors that determine your credit score, and should ideally be above 720. A higher credit score signifies a lower level of risk for lenders and translates to better terms for borrowers.
How to build a strong credit score?
Establish a strong credit foundation: For those just starting, or rebuilding their credit history, it’s essential to establish a strong foundation. Consider getting a credit card or obtaining a small loan. Secured credit cards, where you provide a deposit as collateral, can be an excellent starting point. Ensure you make timely payments and keep your utilisation under 40% to showcase responsible credit management.
Clear your EMIs on time: Timely payment of Equated Monthly Instalments (EMIs) is paramount in building and maintaining a good credit score. Any delays or defaults in EMI payments are reported to credit bureaus, negatively impacting your credit score. Consistently paying your EMIs on time reflects positively on your credit report and significantly improves your credit score over time. Avoid defaulting on any EMI payments, as that would hurt your credit score.
Managing income and expense: Managing your income-to-expense ratio is another crucial aspect of maintaining a healthy credit score. It’s essential to strike a balance between sufficient liquidity to cover your monthly expenses and savings after deducting EMIs from your monthly income. This is especially true in the case of credit cards. One can get a bit frivolous with credit card spending, but that is one debt trap you should avoid. Regularly review your credit card balances and work towards paying them down to improve your credit utilisation ratio.
Create an emergency fund: Creating an emergency fund serves as a financial safety net. In the event of unforeseen circumstances causing delays in EMI payments, having an emergency fund can be a lifesaver. This fund can be utilised to promptly settle any delayed EMIs, preventing any negative impact on your credit score. Additionally, it provides a buffer to manage unexpected expenses without resorting to credit, ensuring financial stability.
In case of EMI delays, swift action is crucial. Utilising your emergency fund or readjusting non-critical expenses to create an extra buffer for timely payments can help mitigate the impact on your credit score. Proactive financial management is the key to safeguarding and enhancing your creditworthiness.
Avoid applying for new credit: A hard inquiry is made on your credit report each time you apply for new credit, which has an impact on your score. Although it’s normal to look for credit for a variety of requirements, choose carefully when and how frequently to apply. Applying for credit infrequently and only when required can help reduce the impact on your credit score.
In conclusion, building a strong credit score is a strategic and disciplined process that pays off in the long run. By understanding the importance of credit scores and adopting prudent financial practices, individuals can pave the way for better credit opportunities, favourable terms, and financial security. The journey to a strong credit score is not just about numbers; it’s about cultivating a financial mindset that sets the stage for a stable and prosperous financial future.
1. Start with a small ticket, personal loan or a credit card. For no or low bureau scores, a bank may provide the credit product against a deposit
2. Make sure that the EMIs are always paid on time
3. Any delays or defaults in the EMIs are reported to the credit bureaus by the lenders which will have a negative impact on the bureau score
4. Always make sure that you manage your leverage to income ratio very carefully. You should be left with sufficient liquidity to manage your monthly spends, savings after deducting your EMIs from your monthly income.
5. Avoid a debt trap and manage your expenses. Keep your credit card spends not very high as compared to your overall credit card limits.
6. Create an emergency fund to manage any unforeseen circumstances.
7. If for any reason your EMI is delayed, try to pay the same immediately using your emergency fund or delay some of your non-critical expenses to create an extra buffer to pay back the delayed EMIs.
Review your bureau reports every six months, and learn how to review the report. Any inconsistencies in the report with wrong reporting immediately escalate to the credit bureau.
Yogi Sadana, Founder of Zype
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Updated: 20 Nov 2023, 08:57 AM IST