Loans have become an important part of our financial lives. We need to maintain an excellent credit score if we want easy approval of loans at an attractive rate of interest. That’s because it has become a norm for almost all banks and financial institutions to check the applicant’s credit score before approving the loan. It is a good way to assess whether the borrower has displayed financial responsibility in handling debts in the past. It helps gauge the risk associated with lending money.
One may do everything right to maintain an impeccable credit history, but can just one mistake damage one’s credit score? What if you usually pay your bills and loan instalments on time, but forget to pay a bill once altogether.
Payment history forms an important component in the credit score calculation. In fact, 35% of the weightage is carried by the way you handle your payments. While on-time payments suggest that you are a reliable borrower who will repay the debt on time, a late payment is an indicator of credit risk. It has the greatest and a long lasting impact on the credit score. How severely your credit will be affected will depend on how late the payment is, how frequently you are making late payments, whether you have missed them altogether, and what your current score is. If you have an otherwise good credit history a single late payment can cause a 10% drop in your score.
Neglecting an account completely may result in your account being sent to collections. But it depends on how much overdue your payment is. If your payment is less than 30 days late, chances are that your credit report will not show up this information. That's because there is usually a grace period of 30 days before a bad remark is reported by the bank. Payments overdue for more than 30 days get reflected under different headings depending on how late they are-30 days, 60 days, 90 days etc. All other things remaining the same, 90 days overdue payment will have a more severe impact on your score than 30 days overdue payment. After the 90 day period, the debt is usually charged off or sold to a third party collection agency. Once your account is sent for collections, your name will enter the loan defaulter's list. It means that you haven't paid the amount as agreed. This will further dent your score and the bad remark will stay on your report for several years to come.
If this happens at the time you are planning to take out a home loan, you will be majorly impacted. Lenders will see late payments as a warning sign that you do not have sufficient finances to honour your current obligations. To cover for this risk they may charge a higher home loan interest rate. Since a home loan is a long term liability, a difference of even a small percentage of interest rate may translate into a difference of thousands of rupees.
Apart from the effect on the credit score, a late payment may cost you money in terms of a late fee. Frequently missed payments may force the lenders to raise the interest rates. Hence one must avoid late payments as far as possible. Even if a financial crunch caused you to default on payments, make sure that you get your finances back on track and do not have more than 90 days past due accounts.
But what if your name already entered the loan defaulter's list? Is there a way you can remove these negative remarks and improve your score? Write a goodwill letter and try and negotiate for a pay for removal deal with the lender. Sometimes lenders agree to stop reporting the item to the bureau, if you pay off the debt completely.
Alternatively, make on time payments going forward and slowly old negative information will age off and have a lesser impact on your credit score. Consider setting up automatic payments or calendar reminders so that you do not forget the payment schedule. Get your free credit report from all the three bureaus so that you find out about late payments that you weren’t aware of. If you are unable to arrange for finances, talk to the lenders beforehand and find out if they can restructure the payment plan and shift the due date to a later date.