Most of us would have taken loans at some point in our life. Either an education loan for paying your college or a loan for your vehicle or you would have bought your dream home. Other popular form of debt is credit card.
Whichever method you borrow money from a bank or a financial institution, do make sure that you repay it regularly and and start at the earliest.
First reason is simple, every month you miss your regular payments, the amount you end up paying would begin increasing. Money always grows exponentially – especially if owe it to others. And the penalty you pay for late payments also eat into your savings.
Second reason is something that is even more important – your credit score. Your credit score is basically a number from 300 to 900 given by an organization called CIBIL. Whenever you apply for a loan or credit card your bank asks CIBIL for your credit score and credit report. And all banks/financial institution sends a report of your loan repayment regularly – so your score is updated frequently.
If your credit report is good, you get your loan and at better terms. If your credit report is bad, you may get need to pay higher interest rates and worse your loan application may even be rejected.
CIBIL calculates the credit score based on 5 important parameters and each parameter has got its own weightage:
- Type of credit used – 10%
- Recent search for credit – 10%
- Length of credit history – 15%
- Credit Utilization – 30%
- Payment history – 35%
If you see the last parameter, you can see that your payment history has the most weightage. Which means, every time you miss out on the monthly payments, your score falls significantly.
The reason for this is plain logical. Lets say you have two friends Alice and Bob who both have borrowed Rs.10000 from you. Alice returned the money in 5 installments of Rs.2000 each without any default. Bob on the other hand returned Rs.2000 only for the first month and paid the remaining installments only after a year. If they both come and ask for money again, Who would you give your money? Naturally Alice – because you don’t want to take the risk again. Banks are similar and they don’t want to risk their money by lending to someone who are prone to defaulting on their repayments.
And this means, repayment of all kinds of credit you have utilized. It could be the monthly EMIs you pay for your car/house loan as well as the monthly credit card bill. Lot of people pay just the minimum balance on their credit card bill. That is a very bad, bad thing to do. Credit cards have a very high interest rate than your traditional loans.
So make sure you have a plan to repay all your loans as regularly as possible and if you can even decrease your expenses so you have extra cash to pay a little bit extra. This is the first step which you must take to fix your financial life.
You may ask is it possible to know what your credit score is? The banks get it, why can’t we? Tomorrow we will see how to apply for and get your credit score within a few minutes.