Stretching out a meagre budget to cover daily expenses, savings and emergency spends can become a tight balancing act for most of us in today’s economic climate. With cost of living indices climbing everyday and salaries not keeping pace, keeping up with card payments and loans can seem like scaling Everest. Failing to keep up with EMI’s and bills could send you into a downward spiral of mounting debt and rising borrowing rates. Missing a payment would adversely affect your credit score, making it more difficult to get a loan or credit card from new lenders. It could also result in your current interest rates being raised, which would increase your borrowing costs and further upset the delicate budget balance. Here are a few tips and ways to save on high borrowing costs while not dipping into your savings or taking out a loan to make ends meet.
Understand Your Credit Score
A credit score is the standard bearer for banks and financial institutions when it comes to gauging the credit-worthiness of an applicant. Whether you’re applying for a credit card or loan, banks use your credit score to determine how liable you are to repay the borrowed amount. Since credit scores are built over time, maintaining a healthy credit score will stand you in good stead if you need to borrow at a later date.
Merely making sure you pay your bills on time is not enough to boost or maintain a good credit score. There are a number of factors that make up how your credit score is calculated, which are outlined below:
- 35% of your credit score depends on your past payments. Unpaid bills or delayed payments can be a black mark against your credit-worthiness, as potential creditors see it as a red flag. Ensuring all bills and EMI’s are paid in full and on time is the best way to keep your credit rating from slipping.
- 30% is determined by how much you owe banks and other creditors in comparison to the line of credit extended to you. The higher the amount owed, the higher the chance of it negatively affecting your credit score.
- 15% is determined by the length of your credit history. Credit history is the length of time you’ve operated an account and your activity through that account. Having fewer and older accounts is a good way to balance your credit history. Ensure payments made from your accounts are on time to avoid being downgraded to a lower score.
- 10% depends on how many recent accounts you have opened and the total number of credit enquiries made by lenders. If you’re shopping for a more economical credit card or cheap EMI’s and applying to different lenders, it could negatively affect your score over a prolonged period of time.
- The last 10% depends on the type of credit you’re utilising. Having instalment debt that you pay on time, such as an EMI indicates to lenders that you are capable of handling large loans over a period of time. However, revolving debt like credit cards impact your credit score more since they are seen as a better indicator of financial behaviour. Paying only the minimum amount due and transferring balances between cards are viewed negatively since they demonstrate an inability to manage your debt.
Based on the factors that determine a credit score, building up good credit seems like a walk in the park- paying off all dues in full, not applying for many loans or credit cards and keeping your credit utilisation ratio low. However, emergencies or situations could arise where you are unable to keep up with your payments.
In such circumstances, the following tips can boost your credit score and keep your finances afloat:
- Pay off essential bills that directly impact your credit score regularly and in full, wherever possible. In the case of credit card debt on multiple cards, pay off the debt on higher interest rate cards first to avoid being saddled with mounting card debt. It is also advisable to pay more than the minimum amount on credit card bills and make payments before the due date, since pate payments directly impact your credit score negatively.
- Avoid closing credit cards or accounts that are not in use, since this rapidly reduces your available credit limit. A drop in your available credit limit would increase your credit utilisation ratio, which should be maintained at around 30%. A rise in this rate would negatively impact your credit score and could result in higher rates of interest when you borrow next.
- Opening new accounts to help manage payments is a good idea, but avoid opening multiple accounts in a short span of time. While this is considered a ‘quick fix’ to raise your credit limit, it also signals to lenders that you are desperate for credit and will directly impact your existing score. Instead, consolidate your debt payments and make them from accounts that you have operated for a long time, as it shows a steady flow of payments. It is also advisable to make payments from these accounts in a timely manner.
- In the case of revolving credit, many cardholders shop around for cards with lower interest rates and then transfer their outstanding debt to this card. While this can help with debt management in the long-term, avoid making too many applications for loans or credit cards. Each time you apply for a card, the lender requests a copy of your credit report. Multiple requests for your credit report in a short span of time is another red flag to lenders and could result in you being rejected or receiving a poor rate of interest.
- Most banks prefer secured loans to unsecured loans and are cautious of lending to applicants whose debt portfolio is mostly unsecured loans. Credit cards and personal loans are two types of unsecured loans that attract the attention of credit bureaus. In the event that you require a line of credit, consider applying for a secured credit card. Secured credit cards offer cardholders a chance to build up credit-worthiness and can be a short-term solution while you consolidate your debt and pay it off. Following this, switching to an unsecured credit card that offers better interest rates and perks can be considered.
Maintaining and keeping track of your credit score used to be a time consuming and expensive process, but now you can check your credit score for free on a number of platforms, such as BankBazaar App. In addition to a credit report, you can also identify discrepancies (if any) and correct them so your score is not affected.