6 Loan Habits That Negatively Affect Your Credit Score
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Your credit score is a crucial indicator of your creditworthiness. It aids lenders in determining whether you will default on your debt obligations and if you are worthy to receive new credit. Your credit score is a generated from your credit history which then reflects on your credit report.
It’s quite obvious that to get a loan you need a positive credit score. This is dependent on a series of loan habits that consistently build rather than destroy your credit reputation. If you’re thinking “then I won’t get a loan at all”, that’s not a solution either; because no history means no risk assessment making it difficult for your lender to ascertain your ability to pay.
If you’re struggling to build your score or simply aim to have a great credit history, then you’re in the right place. Take a look at these six loan habits that will surely demean your score, earning you a negative credit history. Plus, learn how you can fix them.
1. Late/delayed loan payments
Every loan repayment has a schedule to follow. Either a one-off payment or an installment plan. It’s required of you to make timely payments on or before the due date to ensure your score doesn’t lower, and you don’t receive any negative comments from your lender.
Metropol for instance uses a Payment Performance Index (PPI) to measure how promptly you meet your contractual financial obligations. It plays an essential role in measuring a customer’s payment habits to anticipate future behavior, which is then sent to the Credit Reference Bureau for report annually. The PPI index ranges from M1 to M9 where M1 indicates negligible delays while M9 shows delays on average of over three times the agreed time.
If you miss your payment, your score will gradually move from M1 to M9, which negatively affects your credit history. In terms of the score, effects of late or delayed payments can include a reduction of points by 100 to even 300 points, depending on several other factors. The longer you take to repay your loan, the more adverse the effect is.
You don’t need us to tell you how worse it can get after 180 days!
If you find yourself regularly missing payments or slipping and paying them late, then you need to devise a plan to aid you to pay back as little as you can, as often as you can. You can send regular amounts to your lender even before the payment date to ensure you reach the threshold faster. Alternatively, put reminders a day or more before the due date to ensure you can pay on time. Such efforts will reflect well on your credit report.
2. Defaulting on Loan Payments
Missing a payment is one thing, defaulting is a whole other mistake that you should not do unless you aim to be blacklisted. As mandated by the Central Bank of Kenya in 2019, one can only be blacklisted after six months (180 days) of default on payment. However, financial institutions should send reports to the Credit Reference Bureau every day.
This means, the more you extend your payments without notice to the institution, the more you risk bad reviews, which only gets worse when the institution reports you as a defaulter. Not only will you get a negative credit history, but your score will also be affected.
The easiest way to avoid going down this treacherous road is by talking to your financial institution about loan repayment terms. Mombo Sacco offers great incentives on loan repayments like loan restructures, loan moratoriums and debt collection. We offer simpler ways you can use besides defaulting on a loan that would otherwise gain you a bad credit score.
3. High Credit Utilization
Credit utilization is yet another crucial factor that greatly affects your credit. For those with credit cards either from banks or Saccos, your credit utilization rate is monitored by the financial institution to ensure your creditworthiness. A high utilization rate translates to high risk, which then disqualifies or reduces your chances of getting more loans.
To gain frequency on one’s utilization rate, credit bureaus use a scoring tool known as the metro score. This is a measurement tool that checks on a consumer’s creditworthiness based on behavior patterns from factors such as outstanding balances, late payments, total available credit, and the age of your credit account. The score ranges from 200 to 900 where 400 indicates high risk or one with a negative credit history.
This means if you constantly overuse your credit or you have high utilization rates, your score will probably be around 400 which is not good. It means you’re high risk and probably have high levels of debt.
To fix this, maintain a low utilization rate to ensure you have less debt to pay. This also allows you to easily manage your credit card and reduce balance transfers.
4. Numerous Credit Applications
It’s not an unlikely situation that when you borrow from numerous lenders – Saccos, banks, loan apps, and even shylocks, especially if it’s within a short timeframe; that the pile of debt you’re adding to yourself only reflects on your inability to pay.
Financial institutions regularly inform and inquire about loan applicants as they seek further information from the Credit Reference Bureau. They will know that you take out multiple loans and could be a high risk since this is termed as a red flag. Moreover, if you take out multiple loans and over-extend yourself and become very like to default, leaving you with a bad credit history.
Taking out multiple loans is not an issue if you repay them on time. However, the more loans you acquire, the deeper in debt you sink yourself in, which means you become a high risk with a high probability ratio of default. This is rectified by taking out loans one at a time.
Once you take a loan, endeavor to clear the loan before you take another. This saves you from paying high interest, it builds on good loan habits, and can positively affect your credit history. If you’re in such a situation and appear to be deep in debt, then consolidation of debt is good. Mombo Sacco offers this option to its members. By paying off all your debts at once with a larger loan, you can then focus on paying that one debt, avoiding late payments or default.
5. Borrowing High-Risk Loans
High-risk loans are loans with high-interest rates such as payday loans. They run for 30 days and are payable once you receive your salary. Lenders may look at the type of loans you get through a tool called the Q Score. It indicates the quality and quantity of loan you take to assess your credit status.
If you’re not accustomed to such type of loans that have high interest and payable within short periods, don’t borrow them. This is because in the event you miss the payment or default, your credit history will be tarnished.
High-risk loans have higher stakes compared to low-risk loans. For example, instant loans can range from Ksh 3,000 to Ksh 25,000. These loans are short-term, low interest, and easier to pay off. However, high-risk loans have interests ranging from 20% to even 50%. These can easily affect your credit status.
Therefore, avoid high-risk loans if you’re unsure about how you will pay them off. That would be digging your grave. Instead, seek affordable loans that will eventually build and improve your credit history.
6. Maxing Out and Applying for Balance Transfers on Your Credit Card
Last, but not least, is the issue of maxing out credit cards as well as balance transfers from one card to another. We all have a choice of whether to get a credit card or not. The problem comes in when one overuses a credit card to the point of maxing it out.
Maxing out a card means the utilization rate is way above the usual amount, thus pushing forward the debt to the next month up till a point where one is deep in debt. The worst part is where credit card payments are continuously missed or late which leads to the report showing these instances. This negative report will earn the credit card holder a negative credit history in less than three months, and in turn, lower their credit score.
From the image above, we see a case where a customer has received several bad comments about being in default, bad payment behavior, and installments overdue. Their credit score could only get worse.
As for balance transfers, many are also in the habit of taking out a new credit card and moving to it, the balance on the previous one. This doesn’t reduce your debt but it shows how uncommitted you are to paying your debt, which further translates to a bad credit history.
Whether it’s a mortgage loan or any other type of loan, aim to remain in check with your debt. Pay off your balances and maintain a standard form of payment. Aim to keep your credit utilization at a maximum of 30% of your available credit. This leaves you with a good credit standing.
Request for affordable loans and make payments on time
The only way to keep your credit history on the positive side is by ensuring you pay your loans in full and on time. Going for affordable loans only lessens the baggage of having to catch up with your loan repayments and reduces credit stress.
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