Prepaying home loan can HARM your credit score

Sometimes being a good borrower and repaying your loans before time, enquiring for too many home loans or cancelling credit cards can also lead to a drop in your credit score.

Is your CIBIL Score falling inspite of making the right moves?

There are several reasons why your CIBIL credit score could drop down. Not all drops in credit score is due to bad credit behaviour, infact there are some excellent credit related choices which could cause the drop in score. We have constructed some real life scenarios from actual cases to give an insight into why your CIBIL credit score could be falling.

Read to see if you have had a similar experience.

The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.

Scenario 1

Vijay Rajan has decided to shut down all the credit cards he did not use. He had a total of 6 cards and used only 2 of them actively so he now cancelled 4 of his cards.

Behind the curtains

Be careful when closing out cards and keep in mind the credit utilisation ratio. This is the amount of credit you have used, compared to the amount available with you or your credit limit.

Ideally, a credit utilisation ratio of less than 30 per cent is good for your credit score.

If you don't have a good credit utilisation ratio (less than 30 per cent), your credit score can drop significantly low.

In Vijay's case he had a total credit available of Rs 10 lakh with his six credit cards which dropped to Rs 3.5 lakh when he cancelled four of his cards. His spending was around Rs 2 lakh per month on his six credit cards.

Earlier, with six cards, his credit utilisation was just 25 per cent. Now, with two credit cards, his credit utilisation is 57 per cent, which affected his CIBIL credit score negatively.

Scenario 2

Nitin Fernandes had plans to buy a home soon. In preparation for it he made enquiries with some banks and even applied for some pre-approved loans

Behind the curtains

Multiple loan inquiries can raise a flag and lower your score especially if they are spread over a few months. A hard inquiry is when a bank or organization requests your credit score and history and they intend to make a lending decision such as a home loan. Each hard inquiry will serve to bring down your CIBIL credit score.

Scenario 3

Shyama Misra inherited some money and she decided to use it to pay back her home and car loan. She had the loans from different banks and also held related saving accounts in that bank which she closed once she pre-paid her home and car loan.

Behind the curtains

Can paying back your loans before time mean a drop in credit score? Yes, the sudden, large changes introduce some instability in your credit history that temporarily could have a negative effect on your credit scores, though in the long term loan repayment will have a positive effect on your CIBIL credit score.

On the contrary, keeping the loan open and at a low level shows that you can manage the payment each month, and that will help boost your score.