Credit scores and reports often are a source of confusion for many and it's expected since credit rating is still not very old in India. While we understand that no debt (unlike in the past) does not mean a good thing in current times but what if I have debt and I choose to repay it all? So here we look at what happens if one chooses to repay all their debt and be debt free.
When Maya got her annual bonus, she decided to repay her auto loan for which 24 EMIs still remained. After repaying her loan she accessed her report as she planned on taking a home loan a few months down the loan. She was surprised to see a drop in her score, though not drastically but still a drop.
So why did this happen? Let us look at various situations and what impact they may have on the credit score:
In case you have no loans and there are no credit card transactions also then you will have no credit history and hence no scoring can be done. Thus in such a case if a lender accesses the credit report a score of NH (No History) or -1 is given. If the history is less than six months old then the score given will be NA (Not Available) or 0. In both the scenarios the creditworthiness of the individual cannot be judged based on the credit history.
Amongst the various aspects that influence the credit score is credit mix. So a healthy balance between secured and unsecured loans is necessary for a good credit rating. Too much of unsecured debt could increase your risk profile and impact the score negatively. So, if you have too much unsecured debt in the form of personal loan or rolling credit and you decide to reduce the unsecured loan burden then it could help you better your credit score as it will reduce the unsecured debt amount in your credit report. Repaying some part of the unsecured debt could save you from a situation where you have to take a loan for low CIBIL score.
Paying only a part of your debt and repaying all of it so that you are debt free are different situations and hence will have different impacts on your score. Loans are given with a fixed time frame in mind and the lenders also plan their revenues based on the expected timely cash flows in the form of EMIs from the borrowers. The age of credit is also one of the five factors that influence the credit score, the deeper the credit trail the better it is for the credit health of an individual as the prospective lender is able to judge to repayment capacity and discipline of the borrower in a better way. Repayment history is one of most important factors when it comes to score calculation, more recent history is more relevant for score calculation. So when you decide to become debt free, there is no recent repayment history that can help in assessing your creditworthiness and discipline so this can cause your credit score to dip which may actually seem odd to a borrower. A well serviced loan that is run for the entire duration is a good thing for the credit score.
So if you are only looking at reducing your unsecured loan burden with an aim to correct the balance of secured and unsecured debt then it could benefit you. However being absolutely debt free may not be such a good thing for your credit rating.