How Your Credit Card Payment Behaviour Affects Your Credit Score
If you have a credit card or a loan, you have of course heard of how important your credit score is. In fact, you don’t need a credit card or a loan to know just how valuable a good credit score is. The difference between receiving approval for a financial product and your application being rejected, all boils down to this magical number.
What exactly is a good credit score?
Your credit score is basically an indicator of how likely you are to repay your debts. It lets lenders know the probability of you defaulting on your payments.
The Credit Bureau Singapore (CBS) provides each individual with a 4 digit number (their credit score) ranging from 1,000 to 2,000 based on their payment history. A score of 1,000 indicates a high likelihood of defaulting on payments while individuals with a score of 2,000 are less likely to default on their payments.
But this isn’t the only aspect that lenders look at while assessing your likelihood of default. They also go through the risk grade that is provided as part of the report.
Here’s a handy table to help you understand your score:
|Score||Risk Grade||Likelihood of Default|
A favourable score is 1,911 and upwards with a risk grade of AA. While a score of 1,844 to 1,910 may also be looked at favourably by banks, a score below this range may lead to your loan or credit card not being approved.
Thus, it goes without saying that your credit score is important. And one of the main factors that affect this score is your credit card usage and payment behaviour.
Let’s take a closer look at these habits.
1. Having too many credit cards
You probably know that your credit limit with each financial institution is generally up to 4 times your monthly income. So, if your monthly income is S$3,000, your credit limit is S$12,000. Let’s say you decide to bank with DBS. The bank can only lend you credit up to S$12,000. No matter how many credit cards or loans you have with DBS, the amount cannot exceed S$12,000.
Now, let’s assume you have 2 credit cards with DBS with a credit limit of S$6,000 each. You then get a credit card from Standard Chartered with a credit limit of S$8,000 and another from UOB with a credit limit of S$8,500.
You now have 4 credit cards with a total credit limit of S$28,500. This is 9.5 times your monthly income. Sounds great, right?
Not quite. You see, juggling too many cards means that you are sure to run into some obstacle or the other when it comes to making payments or you could max out your credit limit. Moreover, lenders will think that you are too credit hungry. All of which can reduce your credit score.
2. Maxing out the credit limit of all cards
A maxed out credit card is one wherein you are close to or have reached the credit limit on your credit card. For instance, if the limit on your card is S$3,000 and you have charged spends worth S$3,000 to it, your card is maxed out.
This is important because of a little ratio known as the Credit Utilisation Ratio. This ratio depicts the amount of available credit that is currently being utilised. This is calculated by dividing the outstanding balance on all your cards by the total credit available to you.
In our example, both the values are S$3,000, so your credit utilisation ratio is 100%. Which isn’t great at all since a healthy ratio is generally 30% or lower.
How do you prevent maxing out your cards? The easiest way is to request for an increase in your credit limit. The better way to do this, though, is to make a change to your spending habits and cut out expenditure that is unnecessary.
3. Not paying your bills on time
The ‘Account Statement History’ section of your credit report provides all the information regarding your existing credit facilities and your payment history for each of them in the last one year. Any default in payment or late payments will affect your credit score.
It isn’t just your credit score that is affected by late payments, though. When you fail to pay your outstanding balance on time, the bank charges you interest which is typically around 25% p.a. or higher. If you default on your payments continuously, the bank may even charge you a default interest rate which is typically higher than your current interest rate.
This means that the amount you owe ends up increasing. If you fail to pay the complete amount (including the interest) the following month, you slowly begin to fall into a debt spiral. And this only worsens your credit score.
4. Making only the minimum payment required
Making only minimum payments won’t directly affect your score, it will, however, lead to a slow but steadily growing amount of debt.
When you pay only the minimum amount due each month, interest is applicable on the remaining amount. This remaining balance along with the interest accumulated, and the current month’s balance, together form the amount you need to pay for the current statement period. And if you decide to pay only the minimum amount once again, the same cycle follows. Only this time the amount you owe is much more.
If you are looking to boost your credit score, prompt minimum payment is not the way. It’s prompt and complete payment that is required each month.
5. Cancelling a long-standing credit card
This may have surprised you, but CBS tends to look more favourably at credit lines that have been open for a longer period of time than newer credit lines. The reason being that older credit cards give lenders a clearer picture of your creditworthiness. Moreover, when you cancel a credit card (even one which has no outstanding balance) you reduce the amount of credit available to you, thereby increasing your credit utilisation score. And we all know how that adversely affects your credit score.
Does this mean that you should apply for new credit facilities? It is just the opposite actually, since each time you make an enquiry and a bank pulls your credit report, the activity is recorded on your file. Too many enquiries will make lenders think that you are credit hungry and make them decide against approving your loan or credit card application. The higher the number of enquiries the greater its effect on your credit score.
Remember to always keep a track of your credit report. Not just to know what your creditworthiness is but also to know if someone is using your name to obtain credit. The easiest way to keep track of your report is to subscribe to CBS’ My Credit Monitor. You can opt for a 6-month (S$29.96) or a 12-month (S$48.15) subscription and get your report sent to your inbox each quarter.
At the end of the day, it is important to keep in mind that your credit card is an extremely powerful tool. It can make or break your credit score. So, use it wisely.
This article was written by BankBazaar.sg.
BankBazaar.sg is a leading online marketplace in Singapore that helps consumers compare and apply for financial products such as credit cards and personal loans.