The idea of credit is often attached to extremes. A credit card can either become a voucher that facilitates mindless spending, and it can slip into a tentacle of debt that tightens with your every move.
Credit can have good, bad and ugly sides depending on how one uses it. Bankers often look at a few things from the past when giving credit to an individual.
"First and foremost, your credit score, we have our own norm. What is your salary and the predictability of your income?" said Virat Diwanji, a retail banker. "We also look at how many loans you have taken and the EMIs you pay now."
A credit history allows bankers to assess the credit behaviour of the individual. When there is no credit history, especially for young people, the education and employability come into play.
It is important to ensure that the size and purpose of the loan you're taking is small, especially at the start.Virat Diwanji
The Good: Controlled Credit
A person who has not availed credit in the past can build their credit score by ensuring that they make the repayments on their first loans or credit card bills on time.
"You are leaving a footprint with everything you do. One can analyse your spending. Your bank statement is like an X-Ray for the bankers," Diwanji said.
One's credit score gives the bankers a fair view of the credit behaviour as it also helps the bankers understand who they are giving credit to. Lack of discipline shows in the credit report and the bank can take actions that will help the individuals make payments on time, according to Diwanji.
Ensuring that one's credit score does not drop below 650 can ensure that the credit the person has in the system is healthy.
The Bad: Credit Debt
It is never a good idea to max out one's credit card limit. Despite the fact that banks will always be willing to extend the credit limit, it is best to not use the full credit that is available. It is also against the rules to use personal loans to buy any investments like land or mutual fund investments.
A credit-card debt spiral is a vicious circle that an individual can fall into.Virat Diwanji
There is controllable and non-controllable debt. Needs like medical emergencies qualify as non-controllable debt as one has very little control over the amount of money it requires. While discretionary spends that bring debts can very well be avoided.
"On a credit card, it's very easy to just swipe and buy luxury goods. These spends are aimless and mindless," Diwanji said. Debts like this push one into debt and it spirals with the hefty interest on payment delay.
A Way Out
If one is in credit debt, ironically, more credit is one way out. Taking a personal loan that is available with a lower interest rate would help in preventing the build-up of the hefty interest.
The reverse law of compounding will work, he said. Taking secured loans is the primary method that Diwanji recommends if there is a huge outstanding debt.
The Ugly: The Unorganised Sector
Going to an unorganised sector for credit needs to be one's last resort as this space lacks both organisation and regulation of any kind. This means that the risk of credit and treatment of default may end in ugly situations.
In metro cities today, Diwanji says that it is possible to get loans even when one earns in cash and has no proof of income. There are also options in banks where one can ask their employer to verify income.
In small and dangerous sectors like this, it important to sign off as a guarantor. To help out, one can simply sign for an assurance of income or verifying the information.
Also Read: Have A Loan? This Is How Banks Evaluate You
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