How Credit Cards Impact Credit Score?


Credit cards have become quite common today. Thanks to the government which is constantly pushing digital economy, cashless payment systems like mobile wallets, mobile banking, and credit/debit cards are now used by a large number of people. This is because they can use the cards to shop online, avail discounts and cashback perks, build credit score, and more. However, there are certain risks with the cards too.

The way you use your credit cards has a huge impact on your credit rating. So, if you are not careful, then the rating can go down really fast. To prevent that from happening, you must understand the following points:

1. Payments

Your credit card payments have the biggest impact on your credit score. If you are frequently late with the clearance of the bills, then it can have an adverse effect on your rating. This is because payment history makes the biggest contribution in your credit score.

Many people think that if you are late with the payments in a particular month or two, then it can’t make a big difference in your score. However, that’s just a misconception. In reality, every single payment matters. This is why it’s strongly recommended that you create a budget and use your cards wisely. Use only as much credit as you can repay without running into problems. Controlling your expenses can also prevent a situation in which you become a loan defaulter.

2. Credit Utilization Ratio

Credit utilization ratio is the ratio of the amount of credit you use with your cards and the combined limit on the cards itself. Let’s take an example to make it easier to understand.

Let’s say that you have two credit cards and they have a credit limit of Rs. 1 lakh each, which means that the combined limit is Rs. 2 lakhs. Now, if you are spending an average amount of Rs. 70,000 a month with the cards, then the credit utilization ratio can be calculated as:

Credit utilization ratio: 70,000/2,00,000 = 35%

In this example, the ratio is 35% which is slightly above the recommended value which is 30%.

 

The reason you want a lower credit utilization ratio is that the banks consider a high ratio a sign of “credit hungry” behavior. What it means is that when your ratio is high, then it signifies that you aren’t able to pay for your expenses on your own and need help from your cards. This is a bad sign and also suggests a potential loan defaulter in the making.

If you don’t want your credit rating to hurt from high credit utilization, then you should control your expenses as soon as possible. One way to do that is to avoid paying for luxuries and focus on your necessities.

3. Credit Report Discrepancies

Although not directly related to credit card usage, mistakes and typos in your credit report related to the credit card related activities in the past can also hurt your rating. This is because the card issuers may sometimes send erroneous data to the rating agencies. To avoid these mistakes from ruining your score, try to check your report every once in a while and contact the card provider if you find any.

Did you know that you can obtain one free credit report at least once per year? According to the new directives shared by the Reserve Bank of India, all credit rating companies have to provide the users with one report every year. So, you qualify for a free one if you haven’t obtained it yet. In case you already have, you pay a small fee and get an updated version too. Either way, you should get updated report every few months, or rather every month if possible.

Conclusion

As you can see, credit cards may have their uses but they must be used responsibly. If you are not careful, you can end up damaging your credit report so much that it becomes a herculean task to bring the score back to normal range. So, use the information shared above wisely and prevent a disaster from taking place in the first place. Good luck!