Credit Score 101: Building a Solid Foundation for Financial Wellness

Availing of your first personal loan or credit card can be challenging as many banks are hesitant to provide an unsecured credit card or loan to individuals with no credit history. However, building a credit history and an acceptable credit score is challenging without using any credit facility.

The absence of a credit history or a poor credit score can lead to additional complications, potentially hindering your ability to get a home loan or even land a job. Moreover, basic activities such as shopping online or booking a flight may require a credit card. This article elucidates strategies to build a strong credit history and improve your credit score, which ultimately helps build a solid foundation for financial wellness.

Every lending institution, including banks and Non-Banking Financial Companies (NBFCs), adheres to specific eligibility criteria during the loan application approval process. These criteria play a pivotal role in determining whether your loan application will be approved or rejected and in deciding the amount for which you qualify. Among numerous factors, your credit history and credit score are particularly critical in influencing your loan eligibility.

Your credit history serves as a record of your previous loan repayments. Credit bureaus compile information on your repayment history from various sources such as banks, NBFCs, credit card companies, government agencies, and collection agencies. This information is consolidated into a comprehensive report known as a credit report.

A credit score is a numerical representation, ranging from 300 to 900, that signifies an individual's capability to repay loans. The credit score holds paramount importance among the various factors banks and Non-Banking Financial Companies (NBFCs) consider when evaluating loan applications. This three-digit number offers lenders insights into your creditworthiness, with a higher score indicating a reduced likelihood of defaulting on a loan. Hence, a higher credit score increases the likelihood of loan approval, as it reflects a lower risk of non-repayment. At the same time, a lower credit score diminishes the probability of securing a loan.

Refer to the Credit Score Indicator below to understand the different credit score ranges:

In India, there are four credit reporting agencies responsible for computing credit scores:

TransUnion CIBIL

Equifax

Experian

CRIF High Mark

These bureaus play a crucial role in assessing the creditworthiness of individuals or business entities by gathering and analysing their credit data and repayment history. Among these agencies, the CIBIL score from TransUnion Credit Information Bureau (India) Limited (CIBIL) is widely preferred by banks and NBFCs across the country.

1. Apply for a Credit Card:

When providing approval for a credit card or loan, financial institutions typically assess your credit history and credit score. However, the dilemma arises when you need a credit history to get your first credit card. To address this challenge, there are several strategies to get a credit card without an existing credit history. Here are ways to secure your first credit card that can help you build a strong credit history:

a. Apply for a Secured Credit Card:

Secured credit cards are primarily issued by banks with collateral, usually in the form of a fixed deposit. In this arrangement, the bank requires a fixed deposit and provides a credit card with a limit ranging from 80% to 85% of the fixed deposit amount. For instance, if you deposit Rs 5,00,000, your credit card limit would be approximately Rs 4,00,000. Some banks may offer a credit limit equivalent to 100% of the fixed deposit. Since these cards are secured by a fixed deposit, stringent credit score criteria are generally relaxed. Nevertheless, certain banks may set minimum and maximum credit limits for secured credit cards, which can vary.

The issuance of a secured credit card involves minimal risk for the bank, given that it is backed by a fixed deposit. The bank places a lien on the fixed deposit associated with the credit card, ensuring that the fixed deposit cannot be withdrawn unless the lien is removed. Consequently, if you default on credit card payments, the bank or card issuer can utilise the fixed deposit to settle outstanding dues.

b. Become a Second Applicant:

Similar to loans, credit cards can have multiple applicants. If you have a spouse, parent, sibling, or any eligible relation whose credit card application is approved, you can request to be added as a second applicant to their existing or new credit card. The second applicant, or authorised user, receives an add-on credit card and shares the credit limit with the primary user. It is important to note that credit card issuers do not assign a separate limit to the authorised user; rather, they can only share the credit limit of the primary user. The ability to become an authorised user is subject to specific relations as outlined in the bank's terms and conditions. While the primary user bears sole responsibility for repayments, any lapses or delays in repayments can adversely impact the credit score of the authorised user. Therefore, before becoming an authorised user, it is crucial to ensure that the primary user maintains a positive credit history and financial discipline.

c. Apply for a Co-branded Credit Card:

Co-branded credit cards are offered by banks and credit card companies through partnerships with specific brands. These cards generally feature more lenient eligibility criteria, increasing the likelihood of credit card approval. Besides functioning like regular credit cards for various online or offline purchases, co-branded credit cards often provide exclusive benefits such as discounts, cashback offers, and reward points for brand-specific purchases.

It is worth noting that rewards may not be applicable for transactions made outside the associated brand. Examples of popular co-branded credit cards include the Amazon ICICI Credit Card, Axis Bank Vistara Infinite Credit Card, and IRCTC SBI Card Premier.

2. Ensure Timely Settlements:

Failing to meet the deadlines for settling your credit card payments results in debt accumulation and may result in late payment fees. To prevent the high-interest charges and penalties, it is crucial to clear all outstanding dues on time. If you frequently use your credit cards, you may be tempted only to pay the minimum amount due. However, opting for the minimum payment will result in higher interest charges, leading to a substantially larger overall payment.

Therefore, settling your dues consistently in full and on time is imperative. Failure to pay the entire amount due within the specified timeframe can adversely affect your credit score. Hence, it becomes essential to ensure timely repayments upon receiving a credit card. To ensure that you do not encounter delays or overlook monthly payments, it is advisable to opt for an auto-pay facility that facilitates automatic settlement of your credit card bills from your linked bank account.

3. Take What You Can Repay:

The most effective strategy for maintaining or improving your credit score is to choose an Equated Monthly Instalment (EMI) that aligns with your financial capacity, reducing the likelihood of defaulting on repayments. Additionally, it is advisable to refrain from unnecessarily swiping your credit card or opting for a loan amount that exceeds your actual needs solely because the lender is providing a higher sum.

4. Manage Your Credit Utilisation Ratio:

The Credit Utilisation Ratio (CUR) is a critical factor that significantly impacts your credit score. Essentially, it represents the percentage of credit you have used relative to your available credit limit. Calculating your CUR involves dividing your total outstanding dues by your overall credit limit. As you use the credit facilities, your credit utilisation ratio decreases until you clear your debt. It is recommended to maintain a CUR of up to 30% of your total credit limit.

If you have substantial expenses, utilising multiple credit cards can be a strategy to reduce the CUR. Additionally, consistently paying your credit card bills in full is advised. If full repayment is not feasible, limit credit utilisation to no more than 30% of the available credit. If a higher credit limit is necessary, consider requesting an increase from your credit card provider or obtaining an additional credit card to enhance your overall credit limit.

5. Exercise Caution with Multiple Credit Cards:

While effectively managing multiple credit cards can result in a higher credit limit, an improved credit score, and extra rewards, it comes with certain risks. These include the potential for impulsive spending, challenges in overseeing and coordinating multiple credit cards, and difficulties in tracking due dates and repayments. With multiple credit cards, the likelihood of delayed and missed repayments increases, negatively affecting your credit score.

If you are organised, financially prudent, and seek to maximise credit card benefits, maintaining two to three credit cards may be beneficial, providing a higher credit limit, alternative cards for emergencies or technical issues, and potential credit score improvement through effective management of the credit utilisation ratio. Conversely, if managing multiple cards simultaneously poses challenges to your financial discipline, it is advisable to stick to a primary credit card.

6. Restrict the Frequency of Loan and Credit Card Applications:

When you submit applications for new loans or credit cards, the lending institution seeks information about your credit score from credit bureaus. As previously discussed, multiple credit score inquiries within a short timeframe can have an adverse impact on your credit score. Moreover, when lenders decline your applications due to insufficient credit scores, it can further negatively affect your credit score.

Hence, considering their eligibility criteria, it is prudent to meticulously review and compare the details of loans offered by various banks and Non-Banking Financial Companies (NBFCs). Furthermore, it is advisable to opt for one or two lenders that best suit your requirements. While this approach may require more time initially, it proves beneficial in limiting credit score inquiries, ultimately contributing to an increase in your credit score.

7. Diversify Your Credit Portfolio:

Maintaining a well-balanced mix of secured and unsecured loans within your overall credit portfolio is crucial. Overreliance on unsecured loans has the potential to harm your credit score. Therefore, it is advisable to strike a balance between both types of loans. However, if you lack any credit history, initiating with either type of loan is a viable starting point.

8. Monitor Your Credit Report:

It is advisable to review your credit report every 6 months to 1 year. You are entitled to a free credit report each year from all four credit bureaus in India-TransUnion CIBIL, Equifax, Experian, and CRIF High Mark. In the event of any errors or inaccuracies in the credit report, take immediate corrective action. Credit reports also serve as a tool to evaluate the use of your overall credit. For instance, if you observe your credit score being impacted by excessive use of your credit card limit, take precautionary measures to avoid such occurrences in the future, ultimately contributing to the credit score improvement.

9. Apply for an Unsecured Loan or Credit Card:

Upon completing a year of establishing a credit history, if you notice an improvement in your credit score that meets the requirements for availing of an unsecured loan or credit card, you can proceed with the application based on your needs, provided you satisfy additional eligibility criteria. Conversely, if you lack financial discipline and your credit score has either declined or remained unchanged, it is essential to focus on improving it by implementing the same recommendations outlined in this article, such as consistently making timely and full repayments, managing the credit utilisation ratio, regular card usage, and avoiding an excessive number of cards.

In conclusion...

A credit score plays a pivotal role in the approval of your loan or credit card application. While the tips provided in this article help build a credit history and improve your credit score, it's important to recognise that a significant transformation in your credit score doesn't happen overnight. Building a robust credit history requires consistent effort and dedication over time. It is crucial to understand that there are no shortcuts to enhancing your credit score without adhering to financial discipline. By diligently following these tips and exercising patience, you will see positive results gradually.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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