Taking a credit card or a personal loan can affect your credit scores either positively and negatively. The effect that they will have on your credit score will majorly depend on how you are managing your credit. Read on to know more.
Five factors are taken into account while calculating your credit score. All of them have a certain weightage. Those factors are:
Payment history (35%): When you pay your credit card bills or loan EMIs on time, they have a positive impact on your credit score. Late payments, on the other hand, could be bad news for your credit score.
Outstanding debt (30%): Debt that is yet to be repaid is also an important factor. The lower the outstanding debt amount you have, the better and vice versa.
Credit history length (15%): Credit history length gives the lender an insight into how an individual manages long-term credit. If the credit history reflects that you can pay off long term debts on a timely basis, it is a positive for your credit score.
New debt or newly- opened credit lines (10%): If you have taken a loan recently or received a credit card, it will have a short term negative impact on your credit score. But, if you pay your loan Equated Monthly Instalments (EMIs) on time, these new cards or debts can actually boost your credit score in the long run.
Credit Mix (10%): If you have a mix of secured and unsecured forms of credit, it can increase your credit score. The opposite will be true if unsecured loans make up for a major portion of your credit mix.
In addition to the above, your credit utilisation ratio is also a major factor. It is defined as the percentage of your available credit that has been used. 30% is considered to be a healthy credit utilisation ratio. If the percentage used goes beyond that, it can reduce your credit score by a significant number of points.
When you take a personal loan, it decreases your credit score, but that impact is only temporary. But since it increases your total available credit, it reduces your credit utilisation ratio, which affects your credit score positively. When and if you make your EMI payments towards the said loan in a timely manner, it increases your credit score over time.
But, if you pay these EMIs more than 30 days after the due date, your credit score will reduce. The longer you delay these payments, the bigger will be the fall in your credit score. If you do not pay your EMIs for more than 90 days, your loan account will be categorised as a Non Performing Asset (NPA), which will cause your credit score to fall drastically. Additionally, no lender will be willing to give you a fresh loan for some time as NPAs stay in your credit report for up to seven years.
When you get a credit card, your credit score will take a short term hit. But, just like loans, since a new credit card will increase your overall credit, your credit utilisation ratio will come down, which will increase your credit score. If and when you pay your credit card bills on time, a fresh credit card can increase your credit score over time. This is how you can increase your credit score with a credit card.
But, if you miss your payments, delay them or do not pay those bills at all, it will spell disaster for your credit. The longer you delay them, the bigger the fall in your credit score. If you delay them for more than 90 days, an NPA will be recorded in your credit score and it will stay there for up to seven years.
The bottom line is, if you make your payments on time and use your available credit wisely, you can improve your credit score. With the help of a good credit score, you will be able to take fresh loans for your emergency expenses in the future.
As a user of Finserv MARKETS, you can avail one free credit health report and see where your credit score stands.