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Financial Planning 3: Cleaning up credit defaults

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If you have a history of loan defaults, that’s going to do a lot of damage to your financial life. At some point of time, you may require financial assistance from the bank – say, a home loan or car loan and if your credit history is not good, your application can get rejected.  A bad credit score will make it difficult for you to get a loan from the bank.

What happens when you default on a loan?

For reasons beyond your control:  if you have defaulted on repayments because of reasons beyond your control such as a natural calamity or flood, the banks will definitely restructure the loans for you and make it reasonable for you to pay back.

However if you have defaulted due to any other cause for which the responsibility is yours , then it back fires and affects your credit score.

Analyse your loans. Take a list of EMIs you pay and make sure that it’s paid on time. If you have taken high interest bearing loans, enquire if there is any option to reduce the interest rates. Work towards finishing of credit card dues and personal loans first and the start to work on completing other debts as soon as possible.

The CIBIL Trans Union Score:

The CIBIL Trans union credit score is a key ranking relied by banks to ensure that the customer is a credit worthy person. Even educational loan dues can affect the credit score. So if you have a bad loan re payment history, you better start cleaning up the mess.

Apart from loan instalment defaults, the following factors can also make your credit history bad.

Late payment of dues: Loan instalments not paid on time will be reflected in your CIBIL report. So every time you miss an EMI or make late payment of your credit card dues , it directly affects your credit score.

More number of loan enquiries: your CIBIL report will also show the number of enquiries made to different banks – this is not considered as a positive sign from the bank’s side. The assumption is that you were desperately looking for loans with different financial institutions.

Higher percentage of unsecured loans: unsecured loans – like credit card or personal loans are taken when there are emergencies. So , if there is a high percentage of unsecured loans sanctioned to you at various times , it shows that you always had some or other emergencies and you were not able to meet it without taking loans. This is a negative sign and can affect your credit score.

Settlement of loans: in case of loan defaults, the loan recovery team of the bank may offer  to settle the dues at a discounted rate. Such discounts given are called settlements and it will affect the credit score. You might think that since you’ve received the settlement letter from the bank stating that all the dues have been settled, your part is clear. But the reality is that the full repayment story will be reported to the CIBIL with the exact amount allowed as discount.

Already having lot of loans:  a lot of credit means that you have already borrowed a lot and hence, your monthly commitments are already high. Obviously, it’s going to affect your credit score negatively.

Revolving credit or growing credit:  A history of taking one loan after the other with the effect of liabilities growing over a period of time is not regarded as a healthy sign. Taking one loan and then , closing it after sometime by taking another higher loan is called revolving credit. That too , affects your credit score bad.

Long healthy repayment track: This boosts your credit score. To know that you have a long history of meeting financial commitments enhances your credibility.

Co- guarantor for other loans: being a co guarantor means that you will be liable for the other party’s debts. So if your loan eligibility of 50 lakhs and if you have signed a guarantee for another person’s loan for 30 lakhs, your net eligibility is only 20 lakhs.

Taking Loans: is it a good idea or a bad idea?

Too much of loans is a bad idea. However, there are some good reasons why you should take a loan.

  • Having a good loan repayment track is better than having no track at all. Of course, one can assume that you are financially well off from the fact that there are no loans. But on the other side, having no loans does not give the banker an idea about how financially responsible you are. Hence, to build up a good credit score and an excellent credit history, it is always better to have some loan.
  • Some employers check CIBIL score to find out your financial behaviour before hiring you for a job. So from that perspective too, having a bit of loan is good.
  • With an excellent credit score, you can negotiate with your bank to give reduced interest rate son loan , waiver off processing fees , pre-payment penalty and a lot many things. A high credit score can also increase the speed at which a loan is processed by the banks.

So as you can see, there are many benefits if you have an excellent credit history. If your credit history is good, keep up the good score and don’t let it fall at any cost.  If you have a bad loan history, one of the main steps in financial planning should be to work towards the betterment of your credit score and not to let it worsen anymore. Eventually, your credit score will improve and that’s very important from the financial planning perspective.

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