Credit Score is a reflection of your past behavior represented on a scale of 300-900. Higher score represents a better degree of creditworthiness, hence lenders prefer to lend to those individuals with a high credit score.
Having a good credit score not only makes it easier for you to land loan and credit card approvals but get them on favorable terms like a lower rate of interest, lower down payment, etc. While we know that your earlier credit-related factors are responsible for your credit score, let us see how credit cards, in particular, affect your credit score.
Credit Cards and Credit Score
Credit cards are financial instruments of immense convenience. But as much as credit cards can make life easier for us, it is also important to know that credit card debt is one of the most expensive debt with interest rates going as high as 36-48% p.a. So, an extremely responsible behavior is required towards a credit card.
Did you know that your every action- right from your application for a credit card to its utilisation, payment of dues or default or even closing of your credit score- impacts your credit score?
Let us take you through the entire lifecycle of a credit card and what impact each step can have on your credit score.
Applying To A Credit Card
You must have encountered sales associates trying to persuade you to apply for a credit card at various shopping malls or might have received emails or messages extolling the virtues of a particular credit card. You must be thinking it is a credit card after all. How does it make a difference, if I get one more?
Applying to credit does impact your credit score. Let's see how.
When you apply to a credit card, the bank/ credit card issuer has to check your credit score and your credit report from one of the credit bureaus first before approving your application for the credit card. This is done to assess your creditworthiness.
Additional Reading: All you need to know about the credit card approval process
When your lender pulls out your credit report based on your PAN, it is counted as a Hard Enquiry, irrespective of whether the application is approved or rejected finally. If it is a one odd hard enquiry in a year, it doesn't assume much importance. However, if there are repeated hard enquiries in a short span of time, it means that you are unable to manage your expenses within your income and hence, are looking for credit to meet your expenses. This would mean a drop in credit score.
Holding More Than One Credit Card
You may be well within your budget to pay all your card outstanding and hence, may decide to go in for many credit cards. After all, they make dealing with finances much simpler!
However, there is another important determinant of your credit score - borrowing mix. Credit Bureau would like to see you have a healthy mix of secured and unsecured loans. Secured borrowings are the ones secured by a collateral like a home loan or vehicle loan, whereas credit like personal loans and credit cards are unsecured borrowings as they are not backed by an asset.
When you increase the number of credit cards, the borrowing mix may get skewed towards unsecured borrowings. This may result in impacting your credit score to some extent.
Additional Reading: How many credit cards should you hold?
Spending On Your Credit Card
You go in for a credit card to be able to spend towards your purchases online or offline with ease. So, you must be wondering as long as you are able to pay back your spends on time, spending any amount should have no impact, right?
We sadly have to differ here. Spending on your credit card is other terms called Credit Utilisation.
Credit Utilisation Ratio is another important determinant of your credit score. This ratio is calculated based on the proportion of your spend to your credit limit. So, it pays to be careful about the amount you spend on your card, especially if you have a low credit limit on your card.
It is ideal to keep your credit utilisation ratio at 30%.
Always keep in mind that your credit limit is set as the upper limit of spending on your card; it doesn't mean that you have to spend the entire amount during each billing cycle.
Additional Reading: How can you lower your credit utilisation ratio?
Repayment Of Outstanding Balances On Your Credit Card
At the end of each billing cycle, you receive your credit card statement with a record of all your spends during that period. It has one figure for Minimum Account Due and one for the Total Outstanding Amount.
Many amongst you may be thinking that it is good to pay just the minimum amount due. Doing that will just save you from paying the Late Payment Fee. If you pay just the minimum amount required, on the outstanding unpaid and on your future purchases through the credit card, you will still be charged interest, which could be as much as 48% p.a.
Even more, when you do not make payments, the same will be reported to the credit bureau. Do you know that post 30 days your credit card account is termed as a delinquent account, if the minimum account due is not paid?
This can multiply if you have more than one cards and are not careful with your payments.
Payment of EMIs or outstanding balances is one of the most important determinants of your credit score. So, by not promptly paying your credit card outstanding, you are impacting your score in a negative manner.
Additional Reading: How does your credit card interest work?
Closing Old Credit Cards
The general tendency is to close a credit card account especially if you are not using it. There is always the fear of you losing it, misplacing it, etc. Hence, most of us look forward to closing an old card at the earliest.
However, lenders and credit bureaus like to see seasoned borrowers. These are the ones who have been handling credit responsibly for a long period of time. Length of credit history matters here. If the card that you have decided to close is among one of your older accounts on which you have been making consistent repayments, your average credit history age will get shortened and may result in a drop in credit score.
Additional Reading: Learn more on how length of your credit history affects your credit score?
Each and every aspect of your credit card impacts your credit score in one or the other way. Therefore, responsible utilisation of credit cards by spending carefully and only as much as you can repay, prompt repayment of dues, and paying attention to opening and closing of credit card accounts can help you maintain a healthy credit score.