Open banking is the term used to describe a series of reforms which made it safe and secure for customers to share bank details with regulated third parties. This has revolutionised the financial sector, opening up the field for third party apps and online banks to offer a huge range of money management services to […]
What is a credit score and how is it worked out?
If you’re about to apply for credit you are often advised to check your credit score, as it can make a huge difference to the success of your application. What exactly is a credit score? How is it worked out and are there any ways you can improve it?
What exactly is a credit score?
A credit score is a tool that lenders refer to whenever someone makes an application for credit, such as a credit card, a loan or a mortgage. It’s a three-digit number that’s largely based on your credit history, and reflects your previous experience of credit. Did you pay it back as agreed or did you default? Lenders use this information to show them the level of risk you pose should they choose to lend to you.
Is a higher credit score better than a lower one?
The higher your credit rating, the greater your chances of having your application approved. People with higher credit scores are seen as less of a risk, as their score reflects that they’ve successfully managed credit in the past. A higher credit score can also give you access to the most competitive rates.
Every lender uses different methods to assess your credit score. So if you don’t meet the criteria for one lender, that doesn’t mean that all lenders will automatically reject you.
Each lender will weigh up risk against the chance to make a responsible profit. For some lenders that profit will be incremental and built up over a long relationship with the customer. For instance, many people will stay with the same bank for their current account, credit card and mortgage. Someone with a high credit rating is valuable to this kind of lender, so the deals they will offer will be competitive.
For other lenders, it’s less about the long-term relationship, and more about making a greater profit on a particular loan. These lenders may specialise in lending to people whose credit history is less than perfect, as their options may be reduced, and they may not have access to more competitive rates.
If your score is particularly low then it will be more difficult, if not impossible to access credit. So-called ‘bad credit loans’ are targetted at borrowers with poor or patchy credit records, and can be a means to start improving your credit history if used wisely.
If you want to be routinely accepted for credit at the best rates you’ll need to have a decent credit score. The first step to improving your credit score is checking your current credit history.
Why it’s important to check your credit history
Whether you’re looking for a long term competitive rate loan, a mortgage, a short-term or payday loan, it’s helpful to take a look at your current credit history. As being turned down for credit can adversely affect your credit history you should have some understanding of the kind of information that will form the key part of your application. It makes little sense applying to a lender who is targetting borrowers with exemplary credit histories, if your own is patchy. Likewise, there’s no need to pay over the odds for your borrowing if your credit history is flawless. The more information you have at hand, the better prepared you will be.
What information is in a credit report?
A credit report contains all kinds of details about your financial transactions. Lenders report on each account you open with them, every loan you take out, the date this loan began, when it ended, how much credit you were given, your account balance and your payment history. Details of every credit application you make will also be recorded, as too will any defaults or delayed payments. In short, it gives a total overview of how you have handled any credit during the previous six years. As well as financial details it also includes information that helps to confirm your identity, such as your electoral roll entry, linked addresses, searches and details of any court judgements. Historical bankruptcies will usually only feature on your report for six years after being discharged, but in rare cases can feature for longer if the bankruptcy hasn’t been discharged.
Occasionally incorrect information is recorded on your credit report. As it’s the principal tool used by lenders to determine your creditworthiness, it makes sense to be sure that the information it contains is factually correct.
Checking your credit report
It’s relatively simple to check your credit report, and it can become a regular habit. Credit report companies like Equifax, Experian or TransUnion allow you to view your updated report. Although they usually require a subscription, they all also operate a free introduction period. Be careful to check the terms and conditions when you supply your details and cancel any subscription before the free period ends if you don’t want to pay for their services going forward.
What will your credit report show you?
Your credit report will show you what lenders will see when they access your details. It’s broken down into easy to understand sections, so you can quickly get to grips with your current standing.
Let’s take a look at those sections in more detail.
The summary gives you a quick overview of your current credit record. It will also feature your credit score. This is worked out by the credit reporter based on your past credit history. Different credit reporting companies calculate these scores differently, with the greatest variation being among people whose credit history shows some defaults. Lenders will take your credit score in to account when they’re deciding on your application, but the criteria used by each lender will differ, even among immediate competitors.
The summary will also give an overview of any significant factors that could influence your creditworthiness, both positive and negative. This might include missed payments or defaults.
Your profile will contain basic identity information like your full name, any name changes, your age, address and previous two addresses along with how long you’ve lived at your current and previous addresses. Any incorrect information recorded here can cause considerable problems with any credit application, so it makes sense to check that it’s recorded correctly.
People often worry about the impact previous occupants of an address can have on their credit report. The good news is that credit agreements are registered to particular individuals, not addresses so previous tenants or homeowners with poor credit histories shouldn’t impact on your own credit score. If you’ve previously managed credit without any problems but you’re having problems with your credit, it can be worthwhile checking if there’s been a previous issue at your address. It’s unlikely, but it can happen.
As well as your overall credit score, this is the section to which lenders will be paying the most attention. It shows a summary of all your accounts, which will typically include your mortgage, credit cards, bank accounts and mobile phone contracts. It will show the previous 12 months of transactions and balances. Missed payments will show up here, along with information about how your account has been managed. These are two factors that can very quickly drive your credit score down.
If your credit score is lower than you expected, this is where you should find out the reasons why. Just a couple of missed payments can have a dramatic effect. To avoid them in future make sure you talk to your lender if you suspect you might be unable to make a payment. An agreed payment holiday won’t show up adversely on your credit report.
Your entry on the electoral roll is used to confirm your identity. One of the simplest ways you can improve your creditworthiness is by registering to vote if you’re not already on the register. This will show any addresses you’re linked to, as well as guaranteeing your right to vote in the future.
Do you have any other names by which you’re known? This might be because you’re a performer, or have a professional name for some other reason.
If you are financially linked to someone else, such as a spouse, a dependent or a housemate, this will show up on your report. It’s important to check this to ensure that you’re aren’t linked on your report to someone you either don’t know, or perhaps no longer have any kind of financial links with. In some cases divorced or separated partners are still shown as being financially linked even after a clean break. Very occasionally, people discover they are linked to someone they’ve never heard of. This can either be due to an error or an act of deliberate fraud.
The credit status of people you’re linked to will influence your credit score, so it’s important that no one is listed on your report who you have no relationship with. It’s also worth bearing in mind that your finances as a married couple will be considered jointly, so it’s important to be upfront with your partner about how credit is managed within your relationship. If a partner repeatedly misses credit card payments, it will adversely influence your own credit score.
Public record information
Any information that is held about you in the public realm will appear here. This might include bankruptcies, county court judgements, individual voluntary agreements and debt relief orders. These can have a significant negative impact on your credit score so special attention should be made to any details contained here. If something is recorded that shouldn’t be, either because it’s not something you recognise, or has been discharged or expired it should be corrected.
Every time you apply for credit and a search is made on your report, it’s shown here. This lets lenders know if you’re regularly applying for credit, which can be a warning signal that you’re either borrowing too much or are having problems managing your finances. Look out here for any searches you don’t recognise, as too many could be detrimental to your future applications.
Financial associate searches
If someone with whom you’re financially linked applies for credit, it’s likely your credit report will be subject to a search as well. This allows lenders to get an idea of how a couple or other linked individuals are managing their finances. Too many searches from linked individuals can have a negative impact when you’re applying for credit.
The Credit Industry Fraud Avoidance Service or CIFAS is a record of any fraudulent activity that has taken place. This section will normally be empty, but if you find something listed that you don’t recognise you should immediately contact CIFAS who will investigate further.
The ‘Gone Away Information Network’ or GAIN, is a record of people who have moved away from an address without informing those to whom they owe money where they have moved to. If something shows here and it’s an honest mistake you should immediately contact the organisation to whom you owe money and pay back any arrears. You should then request that your GAIN entry is removed.
Correcting your report
If you find inaccurate, outdated or false information on your credit report it’s important to challenge it as quickly as possible. If you missed a payment for a good reason such as unemployment, or ill health a Notice Of Correction can be applied to your report. This is a short statement that is attached to your report explaining the mitigating factors. This is best used when your report is otherwise healthy, and missed payments were a one-off.
If there are errors on your report this is usually due to the lender supplying the credit reference agency with the wrong information. Errors are rare, but when they happen you should contact the creditor concerned and ask them to correct their information. If they agree this should show on your credit report within a few weeks.
The onus to correct errors lies with the consumer, so it’s important to regularly check your report and act quickly.