Loans are part and parcel of our life these days. Anyone who is financially prudent seeks loans to build assets and lead a lifestyle of their choice. Your ability to borrow is not limited to what you earn every month rather your ability to manage finances is something that defines your credit worth. In fact the colour of your credit report indicates your credit health.
Most of us use multiple credit accounts these days like credit cards, auto loan, home loan, personal loan, to name a few. The appetite for credit is not limited to day to day requirements and many of you would desire more loans such as student loan, travel loan or business loan. You can practically borrow for any purpose these days. However your past credit history define if you could borrow more or not.
Anyone who has a current mortgage or multiple loans would probably be using enough of his credit limit. To borrow more you would need to save on your previous loans and create a gap between what you earn and what you are utilizing. It is important to know how to save money on your loans and improve your credit score in the report.
The higher is the score, higher is your loan eligibility. Thus you should always pay attention to your CIBIL score calculation and assess your credit report at least twice a year. Factors that help your credit score include: regular repayment of loans and credit bills, credit utilization ratio, length and age of credits, credit mix and history of loan queries.
Saving on Loans and Improving Credit Score in the Report
One of the smart ways to increase your credit score and avail better rate of interest on a long term loan is by closing your previous loans. By prepaying your previous loan you would build a good history and boost your credit score.
If you are planning home purchase and need loan for the same, the lender would assess your credit history before offering the loan. With low CIBIL score or not so perfect score your low eligibility is low and you could be offered interest on higher rate.
However by prepaying your previous loan you would be marked as a potentially worthy customer and your loan application would be approved. Likewise prepayment of loan also saves you enough money.
To understand how let’s take an example.
Mr. Rajeev Shukla is an IT professional and he has savings of Rs 1000000 in his bank account. His net monthly income (after tax deduction) is Rs. 80000. He spends Rs 10000 as credit card expense every month which he diligently pays before the due date every time. He pays Rs 6000 as his car installment which is calculated at 9 percent of interest every month. The auto installments are due for next 4 years. He wants to prepay auto loan, but he has 4 per cent pre-payment penalty if he pays before one more year.
Mr. Rajeev decides to prepay the auto loan as he plans to raise a home loan of Rs. 3000000 after six months.
By prepaying his auto loan Mr. Rajeev reduces his debt to income ratio. This leaves additional credit limit and makes him eligible for more loan. It also gives him more flexibility to pay for his next loan installment. If he has additional six thousand to pay for loan installment every month he can either have a bigger loan or reduce the loan duration by having bigger installments. Also he can use this money for raising student loan for his daughter’s higher education.
Now coming on to prepayment penalty of four percent, how would he compensate that additional prepayment charge? By prepaying the loan he actually saved five percent which he would have paid as interest in the due course of time. If he could manage to get a better interest rate on his home loan for next 20 years he would further save.
By prepaying loan you would not only save money but also improve your score and worth. Thus a financially prudent person looks at his money from its worth for his future plans and never values it conservatively on its current purchasing power.