It's never a good feeling to see your credit score going down even when paying off debt such as EMIs, bills, or any other payments on time. Many believe that paying off debt on time will improve their credit score. However, if you have noticed your credit score dropping despite making timely payments, don't be alarmed. Several factors can contribute to this dip. Understanding why your credit score is going down when you pay on time can help you take corrective measures and maintain a good credit standing.
At Shriram Finance, we understand the importance of maintaining a good credit score for various financial needs such as loans for commercial vehicles, two-wheelers, cars, homes, gold, personal finances, and small businesses. We are here to help you understand why your credit score may be going down when you pay on time and how to address it.
What Factors Impact Your Credit Score?
One of the most important factors that can cause a dip in your credit score is the credit utilisation ratio. This ratio accounts for 30% of your credit score and measures the percentage of your available credit limit that you are using at any given time. To maintain a steady credit score, it is advisable to use only 30% or less of your available credit limit. For instance, if your credit card limit is ₹50,000, try not to spend more than ₹15,000 in a month to keep your utilisation ratio below 30%.
Exceeding this recommended limit can negatively impact your credit score. If you spend more than usual from last month, it will automatically increase your usage limit and potentially lower your credit score. It's important to note that the drop-in points may vary from profile to profile.
How Long Does It Take for Your Credit Score to Improve After Paying off Debt?
Improving your credit score takes time and consistency. While paying off debt on time is a positive step towards improving your credit score, it may take several months or even years for your credit score to improve significantly. Payment history is the most important factor influencing your credit score, and timely payments over a period of time demonstrate responsible financial behaviour.
What to do to Increase Your Credit Score After Paying off a Loan?
After paying off a loan, it's important to take a proactive approach to rebuild your credit. Diversifying the types of credit you have, can positively impact your credit score. This includes having a mix of instalment and revolving credit accounts. Instalment credit has fixed amounts and fixed due dates for payment, such as mortgages and loans, while revolving credit, such as credit cards, doesn't have specific due dates or amounts.
Taking small personal loans or responsibly using credit cards can demonstrate your ability to handle different types of credit. However, it's important to avoid opening multiple lines of credit simultaneously as it can negatively affect your credit score.
Why Would My Credit Score Drop After Paying off Debt?
There are several reasons why your credit score may drop after paying off debt. One reason is closing old credit card accounts, which reduces the length of your credit history. Since the length of your credit history accounts for 15% of your credit score, closing an account can affect it negatively.
Another reason is if there is a reduction in the available credit limit on one of your credit cards. This automatically increases your utilisation ratio and can lead to a drop in your credit score. For example, if your limit was ₹20,000 and you were using up to ₹5,000 every month but it gets reduced to ₹15,000, then your utilisation ratio increases from 25% to 30%, potentially resulting in a 40-50 point drop in your credit score.
Additionally, incorrect information in your credit report also hurts your credit score. Regularly checking your credit score and disputing any inaccuracies with the credit agencies is crucial. If you notice searches for new credit card accounts you didn't apply for in the enquiry section, it is important to contact the credit agencies immediately.
How to Pay Off Debt and Help Your Credit Score?
To pay off credit, it's important to prioritise high-interest debts first. This can save you money on interest payments and positively impact your credit score. Consider debt consolidation options if applicable, as it can make managing payments easier.
Avoid making multiple enquiries while exploring new financial products or services as it can negatively impact your credit score. Instead, do market research and apply with the lender who you believe will give you approval, reducing the number of enquiries made.
How Do I Keep My Credit Score from Dropping?
Regularly check your credit report for inaccuracies or fraudulent activity to maintain a good credit score. Monitoring your utilisation ratio and keeping it below 30% is also important. Think twice before closing old accounts, especially if they are in good standing, as this can impact both the length of your credit history and the overall utilisation ratio.
Conclusion
Maintaining a good credit score is crucial for various financial needs. Your credit score can drop despite paying on time due to factors like high utilisation ratio, reduction in available credit limit, incorrect information in your credit report, or opening multiple new accounts. It's important to be proactive by monitoring your credit score regularly and taking the necessary steps to improve it.
At Shriram Finance, we understand the importance of a good credit score and offer various tailored solutions to meet your financial needs. Whether you need loans for commercial vehicles, two-wheelers, cars, homes, gold, personal finances or small businesses, we are here to help you take control of your financial future. Contact us today to explore our options and start your journey towards financial success.
Key Highlights:
- The credit utilisation ratio plays a significant role in determining your credit score.
- Closing old accounts and opening multiple new ones can negatively impact your credit score.
- Regularly check your credit report for inaccuracies or fraudulent activity.
- Diversify your credit mix by having both instalment and revolving credit accounts.
