Credit score: Seven myths you need to be aware of

Ranjit Punja

Many otherwise financially savvy people are still somewhat unaware of what exactly goes into making a credit score. There is a little basis to some of the conventional wisdom regarding credit scores and this could lead people to unknowingly cause damage to their score. Here are some popularly held myths on credit scores — and the truth behind them.

A high income helps my credit score

Not true. Your income has little to do with your score. Neither does your job, your education or your marital status. Your credit score is an indication of your general creditworthiness and focuses on your repayment behaviour in the past across all your loan accounts — whether you have paid in time and in full, with no defaults or delayed payments. It has nothing to do with how healthy your bank balance is, your investments or other assets.

Closing old loan accounts will improve my score

On the contrary, closing old loan accounts harms your credit score. You need to close your newer accounts and keep the old ones active. This is because lenders like to have a long credit history with which to judge your repayment pattern. The older your credit accounts, the more information they have of your credit behaviour. Make sure that you not only keep the old credit cards accounts alive but also active. Inactive accounts, however old, will not help your score.

Clean credit slate, with no previous loan, helps my score

Not so. It is a widely held social more in India that all debt is bad debt and that not taking a loan is a mark of a financially responsible individual. However, lenders are nervous when they see an empty credit record as they have no data with which to judge the applicant’s capacity or willingness to repay loans and his/her risk for default. A new-to-credit loan application is a high-risk decision for a lender, and many lenders will turn down such an application right away.

Being on ‘credit defaulters list’ bad for my score

This is a popular misconception with no basis in reality. There is no such thing as a ‘credit defaulters list’ that is supposedly circulated among banks. If you are rejected for a loan, it is not because you are on any list, it is because your credit score is weak and your credit information report indicates faulty credit behaviour in the past. Fear of that much-dreaded list is completely without foundation.

‘Settled’ account status will resolve my credit problems

False. Having a ‘settled’ account may be better than a ‘delinquent’ account, but it will still hurt your ability to raise new credit. A settled status signifies that you have only partially repaid your balance rather than paying off your obligations in full. You need to convert your ‘settled’ status to a ‘closed’ status (indicating that you have fully paid off your balance) for you to be considered loan eligible.

Occasionally delaying payment will not affect my score

Incorrect. In fact, not paying all your bills on time and in full could be the single largest contributor to a poor score. Almost 30% of your credit score is made up of your repayment behaviour and every single late, partial or missed payment is reported to the credit bureaus. While a single skipped payment may not have a significant effect on your score, a pattern of late or partial payments can affect your score substantially.

My credit score will not be affected so long as I spend within my credit limit

Your score could be impacted if you use more than 50% of your credit limit. One of the important factors in your credit score is your Credit Utilization Ratio — the amount you spend as a proportion of your total available credit. The lower the ratio, the better it is for your score. If you spend say, 80% of your credit limit, it raises red flags to lenders about your spending discipline and your ability to discharge your loan obligations. Utilising a high percentage of your credit limit signifies that you are in need of credit and have to stretch all your credit sources to the full.

It is simple to ensure that you have a healthy credit score if you are aware of the main constituents. It is easy to be taken in by myths, but a little awareness and commitment will allow you to create and maintain a healthy credit score throughout your life.

The author is CEO and co-founder, CreditMantri. The views expressed in this article are his own