Timely repayments, borrowing discipline key to credit score

Written by Anil Rego | Updated: Mar 21 2014, 09:11am hrs
Many people earn a lot but spend it all, leading to a lack of investments and savings, and heavy debt. This can create problems as the bigger the debt, the tougher the repayment. Besides, payment defaults also affect ones credit rating, resulting in refusal of subsequent loans.

To evaluate the creditworthiness of an individual, bankers go through his credit information report (CIR) and credit score provided by Credit Information Bureau (India), commonly called CIBIL. CIBIL generates the CIR and credit score for individuals and entities based on their payment record and defaults on loans and credit cards. A good CIR and credit score improve one's chances of getting a loan while a poor score does the opposite. It is important to know how to have a good credit score. One can check ones credit score on the CIBIL website upon payment of a stipulated fee.

Avoid overdue payments. Getting a loan is easier than repaying it. While timely repayment is based on several factors, some of them beyond our control, it is crucial to ensure that repayments are made on time not only it reduces unnecessary friction with the lender, but it also ensures a good credit score. If ones credit history has instances of several late payments, chances are that ones credit score will drop. To avoid late repayments, it is advisable to instruct the bank to pay the money directly via the ECS facility. One should ensure there is adequate money in the account.

Avoid multiple loans. If one has taken multiple loans and one has to repay them at around the same time, missing repayments becomes more likely. Also, in such a case, the major part of ones income gets used towards repayments. To avoid such issues, one should prioritise and take loans only for crucial needs. Lenders view multiple loans as risky, and it affects ones credit rating.

Minimise unsecured loans. Personal loans and credit card dues are examples of unsecured loans whereas home loans and auto loans fall in the category of secured loans. Ones credit score can drop if one holds multiple unsecured loans as these loans give the impression that one is not able to properly manage ones finances. Also, the borrower is seen as a credit risk someone with limited income, but loans without any collateral. Also, as the number of unsecured loans increases, the repayment burden rises, decreasing one's creditworthiness. To have a good credit profile and credit score, it is better to have a combination of unsecured and secured loans rather than just unsecured loans.

Reduce the debt burden. Simply put, the bigger the loan, the heavier the debt burden. This also means reduction in one's future/retirement savings as whatever is earned would be used to repay the loans. This is a dangerous situation as one is constantly fighting bankruptcy. It also increases credit risk and lowers ones overall credit rating.

The writer is chief executive officer, Right Horizons