Understanding credit scores

January 14, 2021

lenders would like to know your future finances, but they can’t see the future. Instead, they have to use predictions of your future based on your past.

Your credit score is a prediction of your ability to repay future loans and credit. It is based on your history of borrowing and bill payments. If you have a good credit score, your past is informing the lender that you are probably able to make repayments on the loan.

Most people don’t know this, but there is no such thing as ‘your credit score’. In fact, we all have multiple credit scores.

In this blog we will first look at why you have multiple credit scores and how they are calculated. We will then look at why and how lenders use them. Next, we will look at what is and what isn’t included in your credit score. Finally, we will look at what you can do to improve your credit score.

What is a credit score?

There are two reasons why you don’t have a single credit score. Firstly, there are several agencies that produce scores. Each of these agencies collects information about you and adds it to your credit report.

Each agency applies its own rating system to your credit report to generate a credit score; giving you different score from each agency. The three main agencies are: Experian, Equifax and TransUnion.

They may have different rating systems, but they all consider the same main elements. The main elements of your credit history include:

·        Payment Reliability – Are you reliable at making payments? Have you ever missed payments? The more reliable you are, the betteryour score will be.

·        Credit Utilisation Rate – This is the percentage of your total credit you use. If have three credit cards with combined limit of£10k and you have used £3k, you have a 30% utilisation rate. Experts recommend keeping this below 30%, and below 10% for the best scores.

·        Credit History Length – How long have you had credit for? Do you keep accounts open for a long time or are you constantly opening and closing them? the longer you have had credit for, the better your score will be.

·        Amount of new credit – what percentage of your credit is new? The more new credit you have, the lower you score will be.

·        Types of credit – they like to see a mixture of credit types, so having a store card, credit card, overdraft, loan, mortgage will give you a better score than if you only have store cards.

·        The number of enquiries – every time your credit file is searched the lower your score will be.

The second reason you don’t have a single score is that the lenders don’t actually see your score. Your credit score is for your benefit. It givesyou an indication of how likely you are to be able to get credit.

What score do lenders see?

There are two types of checks a lender can do on your credit report: a soft check and a hard check. In a soft check the lender asks the credit agency to give them an indication of your credit worthiness. In this case, the lender is given an indication based on your credit score. Soft checks are not recorded on your credit score. Because of this it’s best to use a company that runs a soft check before you make an actual loan application.

The other type of check is a hard check. There are two ways a lender can perform a hard check. The first is to receive a copy of your credit report. Once they have this, they will run their own rating system to decide if you are eligible to become a customer. This means that each lender gives you a personal score based on the information in your credit report.

Alternatively, lenders can perform a hard check by getting the credit agency to run a bespoke rating to their requirements.

How do you get a credit score?

Contrary to what some people think, we are not born with a credit score. In fact, it’s possible, though difficult, to get through life without a credit score.

You get a credit score the first time you do something that would be recorded on your credit report. This could be the first time you: get a credit card, arrange an overdraft, set up a direct debit for a utility company, or take out a mobile phone contract.

Because you don’t get a credit score until you use credit, it’s a good idea to start building up your credit score before you need to use it. If you don’t have a credit score and apply for a mortgage the lender is not going to be able to find out anything about you. It is a good idea to start paying your utility bills by direct debits and to apply for a low value credit card; you should do this at least a year before you apply for your mortgage.

Why lenders use credit scores

People assume that lenders use their credit score to make sure you can afford to repay the loan. They assume that if you have a good score you will be accepted, and a bad score will lead to rejection. This is partly true but isn’t the full answer.

Lenders want customers that can afford to pay back the loan, but they also want customers they can make money from.

If you always pay off your credit card at the end of the month, you will have a good credit score, but the credit card company won’t make any money from you; in fact, the cost of giving you the card means they might even lose money!

Don’t forget that a credit card company makes more money from the people that are constantly running a small balance, paying interest, and making regular payments, than they do from the customers that pays the bill in full each month.

If you have your current account, savings account, mortgage and credit card with the bank, they will happily lose money on your credit card to keep you in their bubble. But if you apply to a different bank, they might now want to give you a credit card even though you have a good credit score.

Banks also make use of teaser products to get you through the door e.g. a savings account with a higher interest rate. Once the bank has you through the door, they can sell you a loan or mortgage…in this case they are not looking for the people with the best credit scores, but for customers they can sell the other products to. If you credit rating is too good, you might get rejected as they know you don’t need a loan.

The electoral register

The electoral register, also called the electoral roll, is a record of every British citizen that is registered to vote. It includes their name and address. Credit agencies use the electoral register to verify the identity of people applying for loans.

You can prove your identity in other ways but being on the electoral register is the best way to prove you exist, prove where you live, and you are who you say you are.

What information is in your credit report

Your credit report will contain the following information:

·        Details of any credit accounts, mobile phone accounts and utility accounts. Including: how long you have had the debt and there liability of your repayments.

·        Details of bank account use. Including: how long you have had the account, how often payments are made and how well you manage your balance.

·        Addresses linked to you. Including: your current address, and also past addresses you have lived at.

·        People that are financially linked to you. Thi swill only include people that you have joint accounts with e.g. a joint mortgage, acting as a guarantor on their loan…

·        Court information. This will include records of: County Court Judgements (CCJ’s), Individual Voluntary arrangements (IVS’s), and Bankruptcy proceedings.

·        Hard searches of your credit report. Including when the search was made, and who made the search.

·        If you have committed fraud.

What information is not in your credit report

Some people think that their credit file acts as part of a government conspiracy theory; as far as we know, it doesn’t. Your credit report doesn’t contain any of the following information:

·        Race, religion of ethnicity. The credit agency doesn’t know this information about you.

·        Income. The credit agency doesn’t know your salary, though you can expect the lender to ask for this information when you apply for credit.

·        Medical history. The credit agencies can’t access your medical records.

·        Family members. The credit agency doesn’t keep a record of your friends or family. They will only keep details of this if you apply for joint credit.

·        Child Support Agency. Information about child support payments are excluded from credit reports.

·        Criminal record. This is only on your credit file if you committed fraud.

·        Parking and driving fines. Even though these matters go through the courts, they are not credit issues and so are not saved on your credit report.

·        If you have checked your file. The credit agency will keep a record of any checks you have made but they don’t share this information with lenders.

·        Savings accounts details. Savings accounts don’t have overdrafts and thus aren’t credit reports. But if you apply for a loan at your bank, they will be able to see their own records of your accounts.

·        If you have been accepted or rejected for credit. Lenders can see if you have previously applied for credit, but they can’t see if you were accepted or rejected.

·        Soft searches made on your report.

·        Council tax payments. Councils don’t share this information. Though you should make this a payment priority as councils are quick to prosecute people that don’t pay.

How to improve your credit score

If you know that in the future you will need a loan or mortgage, you should start working on your credit score now. The first thing you should do is check your score.

Once you know your score you can decide if you need to work on improving it. Here is a list of simple things you can do to improve your credit score:

·        Check it and identify any errors. If there are errors report them.

·        Set up direct debits for your utility bills.

·        Spread the utility bills between yourself and your partner.

·        Build up a small credit history. This could be by using a low limit credit card to purchase the family shopping with; don’t forget to pay off the bill.

·        Switch from a pay as you go phone to a monthly contract.

·        If you rent your property, add your rental payments to your credit file. These are large regular payments that can influence your credit score.

·        Be reliable with your payments, and certainly don’t miss any.

·        Stay within your credit limits and don’t go overdrawn. This looks like you can’t manage your money.

·        Don’t take cash advances from your credit card!

·        Pay more than the minimum payment. Only paying the minimum payment will make other lenders worry if you can afford any more credit.

·        Be careful about linking your account to others. If those people have bad credit ratings, yours will suffer.

·        Clear any outstanding CCJ’s.

·        Avoid payday loans. These can be a red flag to other lenders as they suggest you can’t manage your budget.

·        Manage your current account, and don’t regularly go overdrawn.

·        Use online tools that let you search for credit using soft searches. When you find a suitable provider, they can then make a single hard search on your report. This looks better than lots of hard searches being made.