Having a good credit score is advantageous in several ways. It helps you qualify easily for your preferred loan product and avail favourable interest rates. Unfortunately, even minor missteps can cause your credit scores to plummet.
If your credit score is low and you’re working to rebuild it, you must avoid any mistakes that may further damage your credit score. In this post, we list out the common errors that you should avoid while rebuilding your credit. Let’s get started.
Mistake #1: Failing to Review your Credit Report
The first step to rebuilding your credit score is to find out what is dragging it down. To find this, you need the latest copy of your credit report. You can get a copy of your credit report and score within a few minutes by just providing a few details at CreditMantri.
Once you have a copy of your credit report, spend some time analysing where you’re going wrong. See if any mistakes have been misreported. If yes, raise a dispute with the credit bureau or your lender and get it removed from your report.
Mistake #2: Missing Some Payments for the Sake of Others
Prioritizing which outstanding balances to pay first is smart. But, the mistake here is that skipping certain payments for others. If you’re looking to rebuild your credit, you need to ensure that you don’t miss any payments.
When you continue missing payments, your score gets worse instead of better. Try to find out which of your credit accounts have gone to collections and which aren’t. If you should choose between an account in collection and another that is current, repay the current account first and get back on track.
To build a positive credit score, you need a positive payment history. Try to see if you can liquidate any investment like a Fixed Deposit to repay your outstanding balances and get back on track.
Mistake #3: Closing Old Credit Cards
Very often, the primary reason why individuals have trouble with their credit score is because of using too much credit. They have either maxed out their credit cards or have taken too many loans.
If you find yourself in such a situation, it may be tempting to close all old credit cards and start anew. People with huge credit card debt often assume that closing all credit cards will help boost their credit score. This is a cardinal sin that can further hurt your score.
Closing old credit cards has the opposite effect on your score. Closing old credit cards can hurt your score in several ways:
- First, it reduces the length of your credit history.
Your credit history is the time during which you have been actively using credit. The longer the credit history, the more favourable it is on your credit score. When you close an old credit card, it erases your credit report’s associated credit history, thereby reducing the average age of your credit history. This causes your credit score to drop further.
- Second, it reduces the available credit limit, which, in turn, hurts the credit utilisation rate.
The credit utilisation rate plays a crucial role in determining your credit score. The utilisation rate determines how much credit you have used over the overall available credit. For example, if you own two credit cards with a limit of Rs. 50,000, and Rs. 30,000, then your overall available credit limit is Rs. 80,000. Of which, you use Rs. 40,000, then your credit utilisation rate is 50%.
Ideally, your credit utilisation rate should be below 30%. The lower the credit utilisation rate, the better it is for your credit score. Continuing with the above example, let’s assume that you close the second credit card. This brings your overall credit limit to Rs. 50,000. Let’s assume that you use Rs. 40,000 on it, which increases your credit utilisation rate to 80%.
As you can see, when you close an old credit, it reduces your available credit limit. This means, any balance you owe on the card makes up a bigger percentage, thereby increasing your credit utilisation rate, which in turn hurts your credit score.
Mistake #4: Staying Away from Credit Cards
If you have trouble with your credit score, then it’s tempting to stop using your credit cards altogether. After all, no credit usage means no risk of overspending and no debts, right? Well, no!
The reality is that you need to use credit to build credit. Your credit score is an indicator of how responsible you’re with debts. This is especially crucial when you’re working to rebuild credit. Don’t give up credit entirely, instead use it responsibly to make it work in your favour.
Here are a few ways to use credit smartly to rebuild your credit score:
- Use your credit card to pay for your routine purchases. Ensure that you monitor your credit card usage carefully and repay your bills on time and in full.
- If you’re tempted to overspend on your credit card, then you can use it just for certain payments every month – say to pay your postpaid bill or a Netflix subscription. This way, you build a positive payment history on your credit card without overspending.
Settling your credit card bills on time and in full is an excellent way to rebuild your credit score.
Mistake #5: Using only one Type of Credit
Your credit card payment history is just one of the many factors that influence your credit score. If you’re working on rebuilding your credit score, then having different kinds of credit in your profile works in your favour. Having different types of credit is better than no or one kind of credit alone.
Your credit score is higher when you have multiple types of loans like a car loan, a home loan, a personal loan, etc. Taking a short-term personal loan and repaying it on time does wonders for your credit history and score.
A word of caution, though: taking a loan and failing to repay it on time has the opposite effect on your credit score. So, make sure that you are responsible for the loan you take and repay it on time.
Final Thoughts: Rebuilding your Credit Score is Worth the Effort
Rebuilding credit doesn’t happen overnight. It takes time and effort. You need to make on-time payments, use credit responsibly, monitor your spending, lower your credit utilisation rate, and much more.
Your credit score not only impacts your current finances but also has the potential to impact your future finances as well. Hence, the time and effort you put in are certainly worth it. Now that you know the mistakes to avoid, ensure that you stay away from them. Stay on track and watch your credit score build over time.