How to improve your credit score: part 1
By Kevin Allen | Wed 18 Nov 15
By Kevin Allen | Wed 18 Nov 15
This is the first in a two part series, looking at what a credit score is and what it means for you. Later in the week, we'll be looking at how you can improve your credit score.
A credit score is a number which helps potential lenders decide how creditworthy a loan applicant is – or in other words, how likely they are to repay a loan. The credit score is usually a number between 0 and 999 and generally a higher number indicates higher creditworthiness.
Credit scores are calculated by credit agencies – the biggest three UK agencies are Experian, Equifax and Callcredit. The agencies gather various information on people and use it to assign a score. This information is used by financial companies such as RateSetter so that they can make better-informed decisions on whether or not to lend to loan applicants. The score plays an important part in decisions, but it’s not the only thing that lenders consider.
Your credit score is very important, as a low score can mean that few, if any, lenders would want to approve a loan application, and even if they do, you’re likely to be charged a higher rate of interest. On the other hand, a high credit score can mean that you’re able to borrow money at a lower rate of interest.
Luckily, you do have a degree of influence over your credit score, although – rightly – you can’t manipulate it. However, like all systems, there are limitations with credit scoring, and some people can be assigned a lower credit score than they ought to have. Sometimes the credit rating algorithm simply gets it wrong. For example statistical outliers, such as people with multiple mortgages, can be difficult to score using a system designed for the masses. By understanding the process, you’ll be able to ensure that you present yourself in the best possible way to lenders.
How accurate are credit scores?
Credit scoring is based entirely on factual data, but the truth is that it can’t always perfectly predict whether someone will repay a loan. Credit agencies gather a range of information from checking that person is on the electoral register, to whether he or she has a history of paying bills on time. More and more data is becoming available to credit reference agencies, which now typically includes your payment history for utilities such as gas and electricity, but also whether you are repaying your telecoms bill (there was a time when the last bill a customer would miss was their mortgage payment, but this has changed).
Generally, this information proves to be a reliable guide to whether someone will repay a loan or not, but it’s certainly not a guarantee: to use the financial catchphrase, ‘past performance is not a guide to the future’. While credit scores are continually becoming more accurate, there are still limitations with the data.
So do credit agencies decide who to lend money to?
Credit agencies don’t decide whether you can borrow money: their role is to provide information and guidance: its then up to each individual lender whether or not to give you a loan, based on their own criteria and interpretation of the credit score. Ironically some credit card issuers choose not to issue cards to very low risk customers because typically they will always pay their outstanding balance, and therefore pay no interest. Sometimes credit card customers want customers that are high enough risk to go into debt and pay interest, but not so high that they can’t pay the minimum payment percentage amount.
Additionally, most financial organisations will have policy rules that may override the credit score in certain respects. For example their policy may be not to lend to you if you’ve taken a pay-day loan recently, even if you’ve paid it off. Some mortgage lenders will not consider your application if you’ve missed a single payment in the last 12 months, irrespective of your credit score which could be high if everything else is pristine.
Sometimes this works in the favour of companies that do not take the “computer says no” approach: for example a customer who has perfect credit, a mortgage and is on the electoral roll but on one occasion forgot to pay their mobile phone bill would be an auto-decline to many banks or charged a higher rate of interest. RateSetter is able to look at things more pragmatically and override an anomaly like that.
I have a perfect credit score – why can’t I borrow money?
There are a few reasons why this might be, but the most common is what we call a "thin file". Imagine that someone is so adept at managing his money that he’s never had to take a loan. He has no need for a credit card because he always puts away more than he spends.
The challenge for a credit agency would be that they don’t have access to much information on him – he’s never done anything wrong, but equally he’s never proved that he can repay a loan. That means that he’d have a “perfect score”, but that score wouldn’t tell us anything meaningful about him, and we’d need to do further checks.
So, what can you do to ensure that your credit score is as accurate as possible? Later this week, we'll publish our guide, with some pro tips to help you make the best of your score.
Hopefully you'll find answers to your questions in our FAQ section.
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