What Implications Do Late Payments Have On Your Credit Score?
Besides earning capacity, a lender is interested in your financial discipline. The banks/financial institutions that you apply for a loan or credit card with will want to know if you will repay your dues and on time. This can be ascertained by how well do you handle the money you made or borrowed in the past.
Your credit history is important for these creditors and that is reflected in your credit score.
If you have delayed in making a payment in the past, you may want to understand the extent of damage that could do to your credit score.
What is the difference between late payment and a default?
If you have missed the due date on your payment by a few days, you will be charged a penalty probably on a monthly or daily basis for the number of days of delay. It is late payment when you miss the due date for a single scheduled payment.
If you make the payment before the next due date with a penalty, your credit score will not see any permanent effect.
However, when one misses several payments over a period, it will be termed as default. In case of a loan, if the installment due towards the loan is not paid within 90 days of the due date, it will generally be classified as a non-performing asset (NPA) by the bank.
Defaults affect one’s credit score gravely. It could make borrowing money in the future very difficult.
This is because, in the case of late payment, it is only the consumer’s credit score that will be affected but in the case of a default, the bank’s financial state and reputation are also at stake.
A bank or financial institution aims to reduce the extent of NPAs as much as it can. Further, if the NPAs keep mounting, it will come under the radar of RBI and the institution could even lose its license to carry on business.
As for a borrower, a low credit score will mean getting a loan or credit card in the future will be very difficult. Even if one is offered a loan, it will be for a smaller amount than what the borrower wanted and at a higher interest rate.
The quantum of the loan amount will also depend on the individual’s income and his/her existing debt obligations.
The riskier the customer, the higher the interest rate charged.
The type of credit product availed also has differential consequences. While a delay in the payment of a credit card bill by a few days is negligible, missing on EMI payment towards a big loan is serious. Just a 30-day delay could bring down your credit score by 100 points.
To what extent do you have to suffer the consequences?
The consequences again depend on the amount of default and the number of times payments were missed. Also, it depends on when you apply for the next loan and what kind of loan you apply for.
Ideally, your credit score should recover in one or two years if you made a single default according to experts. Hence, it is very important to maintain a good credit score, especially to avoid auto-rejections on applications for bigger loans.
For example, if you are applying for a home loan that stretches to 10 to 20 years of repayment cycle, the bank/financial institution will study your credit activities for the last three to four years before taking the risk of lending the money to you.
It is important to keep your credit trail as clean as possible.