Many alternative credit scoring models have come up in the past few years. So, do career beginners still need to use their credit card to build a credit history? We ask the experts.
Arun Ramamurthy, founder, Credit Sudhaar
When it comes to credit history and any form of lending, the traditional forms of underwriting are still predominant in the industry. So, having a good credit history and credit score means that the person (seeking a loan) needs to have different types of credit transactions in her history. It is not just the type of credit that is important, but also the depth that will have an impact on the lenders’ decisions. The algorithms that credit bureaus use to score the creditworthiness of an individual use payment history, types of credit and mix of credit. Mix of credit is important as it has a weightage of 20-25% in the credit score calculated by credit bureau. No bank will give a home loan to an individual with no credit history or to someone who has joined the workforce recently. So to that extent, a credit card can help in having a good payment history, and the depth and mix of credit that can help a lending institution in taking decisions quickly. The alternative credit models are helping where credit history is not available, but those are being used for very small loans. These are not big-ticket loans. The alternative scoring models are also nascent. Even in developed markets, alternative history is being used in conjunction with traditional credit scores. Yes, there are some new-age fintech companies that rely on alternative scores, but they are just a drop in the ocean of lending.
Hrushikesh Mehta, VP and head - direct to consumer interactive, TransUnion Cibil Ltd
While there is a lot of work going on in developing a predictive lending model based on alternative data in the fintech arena, there isn’t a clear winner in this space as yet. So the answer is yes, a credit card is an excellent way for a new-to-credit consumer to build a good credit score. The obvious question is, ‘Why do you need one?’
A good credit score can save you money. Lenders are increasingly moving towards rewarding consumers who demonstrate financial discipline by offering reduced interest rates to consumers who have a high credit score. Sometimes the discount can be as high as 1% on a home loan. As a rule of thumb, a 1% reduction in your home loan rate will mean one less year of payment.
If it is sometimes difficult for people with no credit score to get approved for a credit card; they can try getting a secured credit card, which is issued with a credit limit against a fixed deposit or can apply at a bank that has their salary account.
Making regular payments will lead to the bank increasing your credit limit over time. However, always pay the entire monthly balance on time. Just like reputation, a credit score takes time and patience to build but just an instant to be tarnished. Even one late payment will result in a lower credit score and could restrict your access to funds in the future.
Manu Sehgal, business development leader, emerging markets, Equifax
Yes, if you don’t have any credit history, and this is your first ever credit, then you can take a credit card to build your credit score. Financial institutions will also find it prudent to give you a credit card with a low credit limit, or even against a fixed deposit, till you have an established credit history and credit score.
But remember to use your credit card responsibly, by keeping the following guidelines in mind.
Do not delay the required monthly payments on your card, as this can negatively impact your credit score. Also, ensure that you are not using your credit card limit to the maximum allowed limit, on a regular basis. This can have a detrimental impact on your credit score.
A longer duration of your positive credit history with the credit card will lead to a positive impact on your score.
Finally, do not shop around for multiple credit cards in a short span of time. This too has a negative impact on your credit score.
In a nutshell, take one or two credit cards, be disciplined in repaying your credit card dues, and utilize the card over a long period to build your credit score. Once you have some credit history built using a credit card, you can then explore other kinds of credit options, or loans, like car loan or a home loan. A balanced mix of credit will further help you to build a better score.
Amit Kukreja, founder, WealthBeing Advisors
A credit card gives us the power to buy goods that we desire but do not have the capacity to pay upfront. It gives a window of time to arrange the money and payback by the due date. It helps in building discipline of repayment and makes us realize the cost of borrowing. It integrates one with the ecosystem of financial services. As a consequence, it builds one’s credit history or credit worthiness that can be used to throw light on one’s financial behaviour.
Having a credit card gives immense financial power to career beginners. Philosophically, one may argue: ‘Why borrow money if one can make the down payment?’ However, systemically having a borrowing capacity is always healthy. And building one’s borrowing capacity starts with taking a credit card. Of course, this needs to be well balanced with one’s payback capacity. Credit cards can be double-edged swords. If used methodically, they can inculcate financial discipline, create one’s credit records, and potentially provide lucrative offers on loans. However, if used with negligence, it can trap one in debt with very high interest amount, ruin the credit score and kill the person’s borrowing capacity. For someone who does not have a credit score, taking a credit card would help build a credit score. But, if you already have a credit record with credit bureau, then to keep one is your discretion.