The fundamental rule that all credit card users know is – pay your credit card bills on time if you don’t want your credit scores to be impacted. Take the case of Rahul, a 30-year-old IT professional. He has always paid his credit card bills well before the due date. So, he was shocked to find that his credit score was 600, even after settling all his bills on time.
It’s true that your bill payment history – credit cards and EMIs – is one of the biggest factors determining your credit score. But it doesn’t just end there. Several other factors play a crucial role in determining your overall credit score. Your payment history generally accounts for less than one-half of your credit score. It lends around 30% to 40% weightage to your credit score. The remaining is made up of several other factors.
So, if your credit score is lower than you expected it to be – then you need to figure out what’s wrong before you can fix it. Here are a few top reasons why your credit score is low – even after paying all your bills on time.
Reason No #1: You have a High Credit Utilisation Ratio
Credit utilisation ratio – also known as the debt-to-limit ratio is one key factor in determining your credit score. The credit utilisation ratio measures your total outstanding debt balance to total available credit limits, expressed as a percentage.
A high credit utilisation ratio indicates that you are overusing your credit. This puts you at the risk of default, even when you make your payments on time. While you settle your bills on time every month, an unexpected catastrophe will likely put you off balance. This could lead you to default on your debts. Hence, credit bureaus mark individuals with a high credit utilisation ratio at credit risk, which in turn, lowers your credit score.
When your credit utilisation ratio goes above 30%, it indicates you’re having a hard time handling your finances. Hence, credit bureaus pull down your score by a few points when you hit the 30% threshold.
Suppose your credit utilisation ratio is frequently over the 30% threshold. In that case, it’s better to request a credit card with a higher limit or open an additional card. This increases the overall available credit limit, which in turn brings down your credit utilisation ratio. When your credit utilisation ratio comes down, your credit score goes up by a few points. However, you have to be cautious that you don’t increase your borrowings as you have a bigger credit limit.
Reason No #2: You Apply for Multiple Loans/Credit Cards within a Short-Span
Whenever you apply for a loan or a new credit card, the bank/credit card company approaches a credit bureau for your credit score and credit report. This is termed as a hard inquiry, and multiple hard inquiries within a short time frame pull down your credit score by a few points. This is why we highly recommend that you avoid multiple loan inquiries/credit card applications simultaneously.
Reason No #3: You have a large proportion of Unsecured Loans
To have a good credit score, you need the right balance of secured and unsecured debt. The risk borne by the lender is lower for secured loans like home loans, bike loans, car loans, loans against property, etc. Hence, lenders prefer borrowers who opt for secured loans. On the other hand, unsecured loans like personal loans, short-term business loans, etc. increase the lender’s risk.
A healthy credit mix means you have a balanced portfolio – secured and unsecured credit. This increases your credit scores. Similarly, when repaying loans, try to settle unsecured loans first so that you maintain a healthy credit balance. Alternatively, suppose you have several unsecured loans. In that case, you can try to consolidate into a single secured loan to boost your credit score.
Reason No #4: You applied for a New Credit Card/Loan Recently
When you apply for a new loan/credit card, your credit score drops by a few points. As mentioned above, when you apply for credit, the lender requests for your credit report and score from the credit bureau. This hard inquiry brings down your credit score by a few points. You can offset this temporary drop by repaying the EMIs/credit card bills for the new credit on time.
Reason No #5: The EMI payments for the Loan you Cosigned is delayed
Very often, we agree to be guarantors/co-signers for loans applied by family members or friends. When you co-sign a loan, you’re liable to pay the EMIs on time. If the primary borrower fails to repay the loan on time, it can impact your credit score as well. Hence, you must consider the situation carefully and evaluate the primary borrower’s repayment capabilities before agreeing to co-sign/guarantee a loan.
Reason No #6: You hold Multiple Credit Card Accounts/Loans
If you have multiple credit cards or ongoing loans, then your credit score may be negatively impacted, even when you pay the bills on time. The reason behind this is that – multiple loan accounts/credit cards increase your debt levels significantly. This, in turn, increases your DTI (debt-to-income) ratio, which brings down your credit score.
Reason No #7: You do not pay your Credit Card Bills in Full
If you have a habit of not settling your credit card bills in full, it can negatively impact your credit score. Paying only the minimum due every month increases your overall debt limits, which in turn, drops your credit score. Additionally, the outstanding amount attracts steep penalties, further increasing your debt burden. So, make it a practice to settle your unpaid credit card bills in full every month.
Reason No #8: There may be Errors on your Credit Report
Though rare, it may occur. Any incorrect information listed on your credit report can negatively impact your credit score. Hence, you must check your credit report periodically to watch for fraudulent activities, misinformation, or administrative errors. If you notice any mistake on your credit report, make sure to notify it to the corresponding credit agency and get it rectified.
Ideally, we recommend individuals to check their credit report for free once every three months. Contrary to widespread assumption, self-requesting your credit score and credit report does not impact your score. This is a soft inquiry and doesn’t affect your score.
If you are disappointed to find that your credit score is lower than expected, you need to watch out for the eight reasons listed here. The best way to do so is to get a copy of your credit report. Use the information listed on it to find what’s impacting your credit score and how to sort it out.