It has been estimated that as much as 70% of the global population is deprived of access to any sort of borrowing as they do not have a credit score. This article explains why having a credit score is critical, how you obtain one and how good borrowing can help to build a good credit score.
What is a credit score?
A credit score, also referred to as a credit rating or report, is a measure of how you manage your personal finances. Credit scoring gives lenders an indication of your future behaviour. Data which reveals how you have managed your finances in the past is assessed to give lenders insight into how you would manage a future loan, including whether you would pay back the loan in a timely way.
A credit score allows the lender to compare a new applicant against their broader customer profile. Traditional consumer lenders such as high street banks use credit reports compiled by commercial organisations, commonly referred to as credit reference agencies. Credit reference agencies tend to use information generated from existing consumer loans to build a profile of each potential borrower. However, this impairs the ability of many borrowers to access loans <> as they have little, or no credit history.
Sophisticated online lendersinvest heavily in hi-tech credit scoring tools to supplement credit reports by tapping independently into as many as 20,000 alternative data points. This builds a more comprehensive picture of each borrower to broaden access to consumer loans to those who are ‘underbanked’.
Why do you need one?
Your credit score is used to determine your suitability for a financial product, which includes everything from a phone contract to a mortgage. To apply for a mortgage or a personal loan, you need to be able to demonstrate to the lender that you can manage repayments. A credit score helps lenders to determine whether to lend to you, how much to let you borrow and how much interest to charge. This is important for many reasons: it helps a lender make responsible decisions and meet rules set out by regulators. This, in turn, protects the customer from excessive debt and the lender from losses.
What details about you are held in a credit score?
Traditional credit reference agencies tap into a broad range of sources to help lenders build a picture of each individual borrower. This includes:
– Name, address (current and previous) and date of birth
– Search footprints on your file, such as applications to open a new current account
– Your financial links to other people
– Any late or missed payments and defaults
– How much money you owe to lenders
– Any court judgements against you for non-payment of debts
– If you are on the electoral register at your current address
– If you have been declared bankrupt or entered a voluntary arrangement to freeze and manage your debts
Credit reports do not include information about your salary, student loans, medical history, criminal record, council tax arrears, parking or driving fines, or the amount of money in your current and savings accounts. This information may, however, be requested to support your application for a loan or contract, in addition to your credit report.
Your credit score is based on information dating back a number of years. In the UK, for example, data can be kept for up to six years. After that point, data is wiped and does not count towards your score.
Be mindful that each credit reporting agency (such as Callcredit, Equifax and Experian) uses different information to build your credit rating. No one in the UK, for example, has a universal credit score.
Sophisticated lenders who use increasingly sophisticated financial technology (“fintech”) to help broaden access to credit for those who have little or no credit history, also tap into publicly available information including data from social networks to help formulate a credit profile. Needless to say, they have equally sophisticated data protection and compliance in place to protect consumer data, and they also seek verification from at least one credit bureau to help ensure that they are lending responsibly.
So, now you know what a credit score is, why you need one and what personal information is recorded, here are ten top tips for building up – or repairing – your credit score:
1. Demonstrate that you are managing your current debt facilities well. Lenders want to understand how well you are servicing your debt. Credit agencies want to see what portion of your available debt you are using and they want to see how you are keeping on top of repayments. If you regularly exceed or are close to exceeding your credit limits, you will be deemed to be high risk. On the other hand, if you maintain your existing debt levels, but you increase the facilities you have access to, you will increase your credit score because you are maintaining your level of debt well within the levels that have been agreed, making you a good borrower.
2. Don’t open multiple new credit cards that you are not using as that does not inform credit agencies of your ability to service debt and having access to a large number of individual facilities will negatively impact your credit score.
3. Try to avoid regularly using overdraft facilities as it creates the impression that you cannot manage your money. Also, overdrafts can typically be recalled within 60 days, which has a negative effect on your perceived liabilities.
4. Review your finances and close any unused credit card accounts. Future lenders may consider you high risk if you have open accounts with high credit limits that are no longer in use.
5. Check for errors on your credit report, particularly late payments that may be incorrectly listed on your accounts. If you spot errors, report them to the credit reference agency, who then have 28 days to delete the information if you can provide clear evidence. The potential fault will be marked as ‘disputed information’ and lenders are legally bound to overlook it when reviewing your credit file. Aim to review your report once a year to ensure you are well positioned for the best deals and able to spot any fraudulent credit applications.
6. Check if your credit history is linked to a partner, or ex-partner, friend, family member or flatmate’s credit score. If they have a poor rating, it can negatively impact on your credit score. These financial connections can be established following a joint mortgage, loan or bank account and even, occasionally, energy bill payments.
7. Signpost your financial stability. Never assume that not borrowing money equates to a good credit score. Lenders look for evidence that you have a record of repaying loans, regardless of your financial status. As an example, entering into a phone or internet contract and meeting the monthly payments reliably will contribute to a good credit score. Retaining the same employer, bank and home address also highlights that you are in a stable position, and therefore more likely to be a dependable borrower.
8. Make sure you are registered on the electoral roll at your current address.
9. Ensure your credit applications are correct and that information provided is consistent. Pay attention to detail and use identical wording across applications for personal information (e.g. address and job title) to improve your chances with security checks.
10. Review your credit score using these free websites and resources:
• See your Experian credit report via the Money Saving Expert Credit Club
• Check your Equifax report every month
• Review Callcredit reports through Noodle
So, the key thing is to not ignore your credit score; manage it. Follow these ten steps, your credit score will improve and your cost of debt should decrease. Lenders want to see that you are a reliable borrower and demonstrating that you manage your finances well will improve your chances of securing the best rates for your future loan and mortgage applications.
