Mistakes that can impact your credit score

Your credit score is one of the most important financial metrics to assess your financial health, but yet is one of the most under-discussed topics in personal finance. If you spend more than 20 minutes researching personal finance, you’ll have heard all about how important a good credit score is for people with an 800+ score. But what does that number mean? And how does one go about attaining it? That is what we will discuss further:

What is a credit score?

Your credit score is a numerical representation of your history with credit, it depicts your responsibility in paying your due bills and is recorded to allow banks to decide if lending you credit is a safe bet. It is calculated based on your past behaviour with credit, which is recorded in your “credit report”.

Your credit report is a document that records everything about your credit activity, from your regularity of payment, the amount owed, accounts opened, types of accounts, and so on. This is used by lenders to make a decision about extending credit to you and deciding your terms for credit (such as your interest, credit duration, and so on). The higher your credit score, the more favourable the terms of credit for you.

Alongside regular banks, your credit score is also assessed to measure your trustworthiness by Non-Banking Financial Companies (NBFCs) and by future employers/collaborators. This is why it is absolutely essential to maintain a good credit score, but how does one go about doing that?

What’s considered for your credit score?

Credit scores are calculated by each country’s unique credit bureaus, and these organizations have their own unique metrics and algorithms for this purpose. So it is impossible to pinpoint exactly what percentage of your credit score is impacted by which certain element, but it is possible to provide a list of basic factors that are taken into consideration.

Payment history:

Your history of timely loan repayments shows how responsible you are as a borrower and reduces your risk of defaulting. This makes you a better candidate for loans with lower interest rates because the bank is taking on less risk by extending credit to you. Payment history is one of, if not the most important factor affecting your score. The opposite is also true; reckless credit activity lowers your credit score, increases your risk of paying more for loans, and can lengthen the time it takes for your application to be accepted.

Credit utilization:

Your credit utilization, or how much of your available credit you are really utilizing, is another important factor that influences your score. In order to maintain a higher score, you should ideally spend between 30 and 40% of your overall credit limit.

Age of credit:

Your credit history is a crucial factor in forecasting your future credit behavior. A lengthier credit history attests to your trustworthiness and is taken into consideration when determining how responsible you have historically been with your credit. Because of this, maintaining open credit cards with a long history is always better.

Total accounts:

Even though it's the most minute factor, it shows how effectively you can balance different types of credit. A combination of secured lines of credit, such as a home loan, and unsecured lines of credit, such as your credit card, demonstrates your capacity to responsibly handle both forms of credit, thus diversifying your credit portfolio and raising your credit score.

But for every factor to consider, there can be a mistake to be made for it. So, here’s a list of mistakes to avoid to improve your credit score:

Mistakes

Single-source loan build-up

If you take too many loans in a short period of time, you’re perceived by the credit bureau as “credit hungry”, which impacts your score negatively. Further, if you take too much of a certain type of credit (Such as unsecured credit) it could throw caution on lenders. Therefore, it is crucial to take a diversified mix of credit only when you need it.

Not monitoring the credit report

Going through your credit report seems like something that would be a given, but it is remarkable how many people don’t do this. Often, amounts can be disputed and/or incorrect, this causes interest to accrue on those amounts and grow to a large sum which will then reflect on your credit outstanding. Further, oftentimes a loan that has been paid off may not be marked as “closed” by the lender, which leads to a further deterioration in your score.

Applying for credit from too many lenders

Every enquiry for credit you make is noted on your credit report, and too many of them can lower your credit score. Only apply for credit when you’re somewhat sure your application will be approved, and narrow your potential creditors down to a couple of lenders for a certain period of time.

Restructuring and Waivers

A restructured loan is marked as “restructured” in your credit report, if this happens then financial institutions tend to be pretty cautious with the credit they lend you. And if your restructuring allows for any relaxation on terms or a complete waiver of the loan, this raises a lot of red flags. This indicates that it is a possibility for you to be incapable of repayment, and it has happened recently.

Not paying on time

This one is last because it's pretty obvious but it has to be mentioned. The responsibility you demonstrate in your timely repayments can affect your credit score either positively or negatively, depending on your actions regarding payment.

Conclusion

A good credit score provides a lot of credit availability benefits to the consumer and allows the customer to avail pre-approved loans without asking any questions. There’s simply no downside to having a good credit score, but there are a lot of downsides to having a bad credit score. Your credit score can often make a lot of decisions for you and your business, so keeping that number as high as possible is absolutely imperative.