Your credit score is the defining factor in the approval of your loans. The score becomes more crucial when you Apply for a Personal Loan or Credit Card. It is because Credit Cards and Personal Loans are unsecured loans. Banks consider a credit score in the range of 700 and above to be good for approving such unsecured loans. However, the same banks are okay with a credit score of 600 and above when they approve Home Loans. It makes the credit score a complex phenomenon. It is difficult to understand how your credit score works.
Various factors go into the computation of your credit score.
- Your repayment record is the principal criterion for determining your credit score.
- Having a healthy mix of secured and unsecured loans is also important.
- Your credit utilization ratio is essential. However, you should understand that it should be in the range of 25% to 30%. Any figure over 30% indicates that you are hungry for credit. It sends out the wrong signals.
- Making a lot of inquiries is also not advisable. Whenever a bank makes an investigation from their side, it can result in a reduction in your credit score.
People have many misconceptions about credit scores. It is because people do not understand the mechanism behind the working of the credit scores.
Let us look at five myths and facts about credit scores.
Myth 1 – It is impossible for anyone to improve their credit score. It is too complicated to understand.
Fact – Yes, we agree that it is difficult to understand the working of a credit score. But, you can do your best to improve the credit score. You can build your credit with sound debt management and lots of patience. It is important to make payments regularly and that too in full. Delay of any installment can bring down your credit score within no time.
Myth 2 – Frequent verification of your credit report can damage your credit score
Fact– There are four credit bureaus in India namely, CIBIL, Experian, CRIF High Mark, and Equifax. The Reserve Bank of India has stipulated that individuals can apply for one credit report free of cost every year from each of these credit bureaus. Taking out your statement is also known as soft consultation. It does not damage your credit score in any way. Remember, that the broader investigation done by banks to procure your credit score costs you valuable points.
Myth 3 – You can increase your credit score by closing old accounts
Fact – Logically speaking, closing your old accounts should improve your credit score. But, credit reports work differently. Closing your old accounts reduces your available credit. It increases the credit to debt ratio. If you have outstanding balances on other cards, it can result in decreasing your credit score. Credit score depends on the balance you maintain between the limits and the outstanding amounts in your loan accounts. Remember that closing your old accounts do not shorten your credit history. Such accounts remain on your credit history for ten years even after you close them.
Myth 4 – Having a high proportion of secured loans can increase your credit score
Fact – Secured loans are always desirable. Banks also prefer to approve secured loans. But, credit bureaus work differently. You should have a healthy mix of secured and unsecured loans. Banks judge your repayment behaviour in the way you repay your unsecured loans.
Myth 5 – Offering your guarantee for a loan does not affect your credit score
Fact – The liability of the guarantor is co-extensive with that of the borrower. The borrower has the principal obligation to repay the loan. However, in case of default by the borrower, the banks can demand the payment from the guarantor. It can result in a deterioration of your credit score.
The credit report is an essential document. Banks give great importance to the credit score of an individual while sanctioning loans. Knowing your credit score is crucial. You can take action and improve your credit rating when you know the reasons for your poor credit score. In case there are errors on the credit report, you can take action to rectify them. It is possible only when you study your credit score thoroughly.
We have dispelled five common myths regarding credit scores. It should help you to understand the concept better so that you can take steps to improve it.
Also Read: 5 Myths about Business Loans
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