Why ‘No Debt’ might mean a low credit score – What you must know

In India, there is a strong belief that avoiding debt is the best way to stand out and stay away from financial problems. Such a practice also keeps an individual financially healthy. Given this can work for personal budget planning, still it can backfire when it comes to your credit score and your overall credit profile.

According to Bhushan Padkil, SVP and Head – DTC ( Direct-to-Consumer), TransUnion CIBIL, “Building a strong credit score is not about avoiding debt, but about demonstrating consistent and responsible credit behavior. For new borrowers or borrowers without any debt history in the past 36 months, it's important to understand that you won't have a credit score.”

“However, this does not mean that you are ineligible for any credit product. Lenders will assess your credit eligibility through other means such as income statements, tax returns, and demographic details. Once you take on a loan, it is crucial to repay it consistently and on time. This practice not only helps in building a good credit score but also makes future borrowing easier, especially for larger loans. Remember, a good score and report is your gateway to financial flexibility and opportunities," he further added.

Why ‘No Debt’ can hurt your credit score?

Your credit score is simply a three digit number ranging from 300 to 900. It is used by banks and financial institutions to understand and analyse your creditworthiness. If you have never opted for credit i.e., a loan, credit card etc., earlier then your score might be lower or you might not even have a score.

This happens because credit bureaus such as CRIF High Mark, CIBIL, Equifax, Experian among others need a history of your credit behaviour. This helps them in generating a score for every individual. No history simply means no data, and not data means a reduced or lower risk rating.

Hence, someone managing a personal loan or credit card efficiently, might have a better credit score than someone who has never taken credit.

What makes up your credit score?

Credit scores in India are calculated based on the following factors:

• Payment history: Consistent and timely repayment of EMIs and credit card dues is an important factor in deciding an individual's credit score.
• Credit utilisation: How much of your credit limit you use is also an important factor. Staying under 30% is ideal.
• Credit history length: The longer is your track record of efficient credit management, the better it is.
• Credit mix: A healthy mix of secured credit (like home loans) and unsecured credit (like credit cards) is extremely important to help in boosting your credit profile.
• New credit enquiries: Too many different personal loan or credit card applications in a short time can hurt your score adversely.

Now, without any fairly taken and reasonable throughout personal loans or credit cards, these indicators don’t exist. This leads to a poor or non-existent score.

How to build credit without taking big loans?

You can still build a good credit score without taking on avoidable and unnecessary debt:

• Secured credit card: These are credit cards backed by fixed deposits. They are easy to get and can also be seamlessly reported to credit bureaus.
• Making bill payments on time: Timely and consistent payment of utility bills, house rent (through digital platforms to assist in record keeping) along with on time subscription payments shows responsibility.
• Use credit in a calm manner: If you are not a frequent user of credit cards, never max it out. Focus on keeping your credit utilisation below 30%.

Conclusion

Hence, having no debt doesn’t mean a good score. Instead, actively managing small amounts of credit and repaying it on time is the key to maintaining a healthy credit score and a reputable credit profile.

Disclaimer: Mint has a tie-up with fintechs for providing credit; you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards and credit scores. Mint does not promote or encourage taking credit, as it comes with a set of risks such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.