We often tend to blame credit cards for poor credit score and falling into a debt trap. However, this is far from reality given that low credit scores and debt cycle are the result of lack of financial discipline and self-control. A well-chosen credit card is, in fact, an effective tool to increase your credit score.
Here’s how you can build your credit score.
1. Use credit card to build credit history
Lenders prefer lending to those who have taken loan or credit card in the past, given that it allows them to evaluate applicants’ repayment behaviour and associated risk. But, taking a loan just for the sake of building your credit history is not advisable as it comes with interest and other associated costs.
The best way to build credit history without incurring cost is to avail a credit card. Unlike loans, credit cards do not incur any interest cost as long as you pay off outstanding dues in full or do not avail EMI or loan option. Apart from zero-cost finance, credit cards offer additional benefits like reward points, cashbacks, discounts, etc. If chosen and managed well, these benefits can outweigh their cost by a wide margin.
Those who cannot avail regular credit card can opt for secured credit card to build credit history. These cards are issued against fixed deposits, with up to 85% of principal value being offered as credit limit.
2. Pay the bill by due date
Credit card issuers report card transactions to the bureaus for calculating/ updating credit score. While defaults and delays lead to a reduction in credit score, consistent repayments of the entire bill amount by the due date is considered as a positive trait and can lead to a steady increase in the credit score. Thus, always use your credit card for the expenses that can be repaid by the due date. Convert your card dues (in part or entirety) into EMIs if your card outstanding is too big to be repaid by the due date.
3. Contain your credit utilisation ratio within 30%
This ratio is the percentage of the total credit limit used by you. Lenders usually prefer lending to those having credit utilisation ratio within 30%. They consider applicants with higher credit utilisation ratio as credit-hungry and hence, riskier to lend. Credit bureaus reduce the credit score on exceeding the 30% limit while those having lower ratios are scored higher. Hence, always aim at limiting your credit utilisation ratio within 30%. Request a credit limit increase from your existing card issuer(s) if your credit utilisation ratio frequently exceeds 30%. You may also opt for an additional credit card if your existing credit card issuer(s) rejects your request for credit limit increase.
4. Avoid multiple credit card applications within a short span
Registering multiple card applications within a short span of time will pull down your credit score by a few points. Whenever you make a credit card application, card issuers fetch your credit report from the bureaus to evaluate your creditworthiness. This is considered as hard enquiry and this gets included in your credit report, with each of them reducing your score by a few points.
Enquiries initiated by card issuers are considered as hard enquiries, which reflects in your credit report, with each them reducing your credit score by a few points.
Instead of making direct application with multiple card issuers, visit online financial marketplace to compare various credit card offerings. While they would also fetch your credit score, such requests are considered as soft enquiries and hence, do not impact your credit score.
5. Close your old credit card with care
Credit bureaus factor in the average age of your credit facilities, including your credit cards and loans, while calculating your credit score. Hence, closing your older credit card(s) will reduce the average length of your credit facilities, which will lead borrowers to reduce your credit score as well. Moreover, closing your credit card can also reduce your total credit limit. If decreased credit limit leads credit utilisation ratio to exceed 30%, it can reduce your credit score. To minimise the impact on your credit score from credit card closures, request other credit card issuers to increase their credit limit.
(The author is CEO & Co-founder, Paisabazaar.com)