What is a Bad Credit Score?
A credit score is a number used to calculate a person’s “creditworthiness” (or their ability to repay borrowed credit, like loans) by banks and other lending institutions. This is usually depicted by a number between 300-900, which is based on their history of repayment, loan history and more.
In India, there are four licensed credit information bureaus – TransUnion CIBIL, Experian, CRIF High Mark, and Equifax.
What is a Poor Credit Score?
The different credit bureaus have different scoring models. However, in general, a credit score below 650 is considered to be either fair or bad. This group is said to have “subprime” credit scores, and lenders will classify them as people who might have a hard time repaying a loan.
Here are what the common credit score ranges look like:
How did you get this score?
“Not Applicable” or “No History”
No credit card usage or loans. Thus, there is no credit history.
Missed payments or defaults on credit card bills or EMIs, poor credit utilisation, or a high number of credit enquiries, Considered a high risk of defaulting on your loans., Applicants may not be approved for credit.
Irregular or late payment of credit card bills/EMIs or multiple credit inquiries, Considered a risk for lenders, Applicants may be approved for some credit, but interest rates and down payments may be higher.
Good repayment behaviour in the past, Considered at a lower risk of defaulting, Applicants may be approved for credit but not get the best rates.
Regular credit payments, long credit history, responsible repayment behaviour, Considered a low risk for lenders, Applicants likely to be approved for credit with good deals on loans.
Excellent financial management, regular credit payments, low credit utilisation, and exemplary credit history, Considered very low risk for lenders, Applicants likely to receive the best rates and favourable terms on loans and credit cards.
How will a Bad Credit Score affect you?
Having a bad or low credit score will be affected in a number of ways. These include:
- Credit applications being denied: Banks and other lenders are more likely to reject your credit applications if you have a low credit score and a history of managing credit poorly.
- Difficulty obtaining loans: With poor credit, lenders will not be sure that you will not default on them, which could make it difficult or impossible to get approved for loans.
- High-interest rates: Since you have a lower credit score, you will be seen as a higher risk, and you will be charged higher interest rates on your loans.
Those with bad credit will have a number of difficulties obtaining credit and may be forced to opt for higher interest rates, and other, alternative and expensive financing options.
What factors affect your Credit Score?
As mentioned above, an individual’s is a number between 300-900. These numbers are calculated using a number of factors. Each of these factors has a different weightage on the score, but this weightage will change based on the company calculating the score.
The factors that are taken into account include:
What affects these factors?
Timely payments of credit card bills, loans, and EMIs will improve your score, while delayed, missed, or defaulted payments will lower your credit score.
The lower the amount of your credit limit that you use, the more it will help your score. Ideally, you should try to spend no more than 30% of your credit limit. If it is higher than this, it will bring your score down.
The longer you have had your accounts and credit cards, the better for your credit score, as it can show potential lenders that you have consistently had responsible financial behaviour.
There are two major types of credit: unsecured loans (ex. credit cards and personal loans) and secured loans (ex. auto loans or home loans). It is recommended to have a mix of both.
A higher number of “hard inquiries,” i.e., applying for credit, such as credit cards, loans, etc., especially during a short period of time, can lower your score.
What factors will not affect your Credit Score?
There are also a number of factors which do not play a role in calculating your credit score. These include:
- Your account balance, investments, and any debit card usage.
- Your income, occupation, employer, or employment history (though some lenders may still consider this information).
- Your age, marital status, education level, nationality, religion, where you live, and other demographic factors.
- Payment of utility bills, like rent, or phone, electricity, water, and internet bills.
- Being denied credit, or rejected for loan or credit card applications.
- Soft inquiries, when you check your own credit report, or inquiries by others (like your bank conducting reviews of your credit accounts).
What can reduce your Credit Score?
Once you know the factors that affect your credit score, you will be able to ascertain what actions have a negative impact on your credit score. Some of them are as follows:
- Missing or defaulting on payments – Any missed or defaulted payments on credit bills, loans, and EMIs will hurt your credit score. Additionally, the longer your payment is late, the more your score will suffer.
- The amount of money you owe – The total amount you owe, including mortgages, credit card balances, car loans, home loans, etc., will affect your score. The higher it is, the lower your score may be.
- Using too much of your credit limit – Ideally, you should try to keep your credit utilization under 30%. This means that you should only try to use 30% of your credit limit, as using more can indicate that you are too dependent on credit.
- Applying for a lot of credit in a short time – When you apply for new credit, a hard inquiry is recorded on your credit report, which remains on file for two years. Too many inquiries in a short period of time show that you are in a bad financial position and can lower your score.
- Ignoring mistakes in your credit report – Errors on your credit report can lower your score through no fault of your own, so try to regularly monitor your credit score and report.
How to Improve a Bad Credit Score?
Knowing why your credit score is struggling, it can be quite easy to improve your credit score. It may take a little time and effort, but here are some steps you can take to get your credit score above 700:
- Review your credit report regularly so that you can rectify any mistakes.
- Pay your credit card bills, loans and EMIs on time.
- If you have any outstanding payments, complete them as soon as you can.
- Do not use too much of your credit limit; try to keep your credit utilization within 30% (for if your credit limit is ₹10,000, try not to use more than ₹3,000).
- Limit any new credit request, such as applying for multiple loans or credit cards, especially within a short period of time.
- Unless it is absolutely necessary, do not cancel your old credit cards, as older cards can assure lenders that you have been paying your bills on time.
What to do if you don’t have a Credit Score?
While having no credit history and no credit score doesn't mean you have bad credit, it can make it difficult to build a good credit score.
If you have never used a credit card, or you have never taken a loan, you will not have a credit history. This is because most credit scoring models use these credit reports to determine your score. Thus, if this information is not there, they can't create a score or report.
In such situations, here is what you can do to start building credit:
- Get a secured credit card – A secured credit card is one where you regularly pay off your dues. Try to take one out against a fixed deposit with a bank where you already have an account. Your bank will set the minimum deposit amount you need to maintain to apply for a credit card.
- Ensure you can repay bills on time – In order to construct a good credit history, you must be able to repay all your dues at regular intervals.
- Monitor your credit card usage – Since your credit behaviour will be reported to credit bureaus, monitor how you use your credit.
- Become an authorized user on someone else's credit card – You can also opt to be added as an authorized user on a family member’s credit card. You might get a card attached to this primary cardholder's account, and they will be responsible for ensuring that bills are paid on time. This usage will help start your credit history.
- Apply for a loan with a guarantor/ co-applicant – If you need a loan but you don’t yet have a credit history, apply for credit with a guarantor or a co-applicant. This will help strengthen your credit record as the loan will appear on both credit reports. However, remember to be responsible with repayment, as defaults can affect not only your credit score but that of the other party as well.