If you have been in the habit of taking new credit cards every now and then and closing them after sometime for whatever (genuine) reasons, then think twice before you continue such a practice. It might lead to your credit history and credit ratings getting affected in a negative way.
I was casually going through the official website of CIBIL, The Credit Bureau of India, responsible for maintaining credit rating scores for individuals and identified something interesting (as well as disturbing).
In the FAQ section (http://www.cibil.com/faq/consumer-credit-report), under the "Managing Your Credit History" sub-section, there is the mention of following "rules" to maintain a good credit history.
Rule no. 5 seems to be dangerous for credit card holders which, at the time of writing this article, reads as follows:
Rule 5: Think twice before closing credit card accounts. While, using credit cards may negatively impact your credit history, unused credit cards actually imply that you are financially secure. This makes Loan providers view your application more favourably.
Here is a screenshot for the same:
I'm not sure what is really meant by this "rule" as quoted on CIBIL website. Let's look at it step by step:
First sentence: "Think twice before closing credit card accounts"
This worries me a lot. Millions of young Indians employed at IT companies and other sectors are targeted by telemarketers with offers of LIFE TIME FREE CREDIT CARDS. Competition among various banks offering free credit cards is so intense that they even claim to include "free offers" upon taking free credit cards. Just 2 days back, a bank conducted a helpdesk in my office and claimed to have an offer of Rs. 1500 once a person signs up for their lifetime free credit card. The reality - the offer of FREE Rs. 1500 was to be used in different forms - Ayurvedic massage, Purchase of 600 Rs. on a perticular website to get 300 Rs. discount and so on. Effectively, the offer of Rs. 1500 free leads to people being forced to spend much more than 3000 Rs. Then the credit card offering bank will refund Rs. 1500 after 3 months.
This kind of offers lead ignorant individuals to sign up for credit cards and then after the reality about such offers is discovered, they tend to close the card. If we go by what CIBIL has stated in its rule no. 5, such a practice, even though for genuine reasons, might lead to spoiling your credit history.
Who is at fault here? Individuals who are made such offers which are unrealistic? or the credit card offering banks who make such offers? Or the banks who take decision about your credit worthiness based upon your credit card activities?
Remember, its the result that always matter. In this case, going by what CIBIL has on their webiste, the result will be bad for individuals, irrespective of who is at fault.
So beware of the consequences of taking a "free" credit card, even if it comes with "free" cash or other offers. Nothing in this world comes free.
Let's focus on second part now - "using credit cards may negatively impact your credit history". Does it mean that if I use credit cards and even if I make full payments on time, will my credit rating be hit just because I'm using a credit card? This sentence appears to be half cooked.
Again, there is no clarity. It all depends upon the bank which is reviewing your credit score card prepared by CIBIL.
On one hand, government organizations like RBI are promoting use of cards in transactions to control money laundering and fake currency problems, and on the other hand such "rules" mentioned by CIBIL discourage the use of credit cards even for individuals who may full payments in time.
The next part - "unused credit cards actually imply that you are financially secure" - What is actually implied here?
Am I supposed to sign up for multiple credit cards and not use them at all to improve my credit score? Will that indicate that I am financially secure?
Club it with first sentence - "Think twice before closing credit card accounts". It appears to confirm that above understanding - take multiple credit cards, but dont use them at all, and Dont close them either. The CIBIL report, as perceived by other banks and financial organizations, will then indicate you being financially healthy (??).
However, keeping unused credit card is a liability on individual. What if it is lost, stolen and misused by someone? Isnt it better to close unused cards? Wont closing an unused credit card indicate that an individual if financially secure - even better than the one who is keeping unused cards? Someone keeping unused cards indicates that although he is not using it now, he may use it anytime in future. Someone closing a credit card will be more secure because he is certain that he does not need that credit facility at all.
Unfortunately, the "rule" quoted on CIBIL website is other way round.
How credit cards usage affect your credit rating and credit scores
If keeping unused credit card indicates financial security, then closing them permanently (ofcourse by clearing all dues) should indicate a better financial health. Not sure how it is perceived as negative and quoted by CIBIL as a practice to be avoided.
In India, credit score rating is still in its primary stage. Unfortunately, the interpretation of an individual's credit score and rating lies in the hands of loan providers and individuals dont have any say in that. What I'm surprised is at these "rules" being quoted on CIBIL's site which, considering the above mentioned points, dont really make a justification.
Nothing much an individual can do about it.
CIBIL reports are based on the info it gets from banks and other loan providers about an individual. If such banks and loan providers make a mistake and provide incorrect/ negative info to CIBIL about an individual, CIBIL cant do anything to verify that. The individual might have to run from pillar to post and follow up with the concerned bank to rectify the error so that an improved report is sent to CIBIL. This process may take time spanning months. In this process and time involved, if the individual applies for a big amount loan like home loan and it gets rejected because of such incorrect and negative report, there seems to be no rules to penalize the banks for sending incorrect info or compensate the individual. (If readers are aware of any such rules, please post it in the comments section below and this article will be updated after verification of the info)
So in summary, please avoid taking credit cards even if they come with juicy offers. Avoid using credit cards. Keep unused credit cards secure. The more cards you take, the more headache it will create in managing them. A small convenience today might hit you in big way while taking high amount loans.
(If any info mentioned above in incorrect, please post the correct details in the comments section for rectification)
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