A good credit score can help increase the success of many life events like taking out a mortgage, financing a car and more. Having a high credit score will qualify you for better interest rates and can save you more money in the long run!
Credit scores clearly have a big impact on how we live our lives, but what is a credit score exactly, and how is it calculated? If you have a low credit score, is it possible to improve it? And if so, how? These questions and more are answered below in our basic overview of credit scores.
What is a credit score?
A credit score is a number used to describe your financial credibility to others. A credit score is meant to advise lenders and let them better understand if you are a low risk or high risk investment for them. The numbers will vary depending on which bureau your score was pulled from.
Why do I have different scores?
One person with one credit history should have one credit score, right? Unfortunately, no. There are many bureaus but three you may have heard of: Experian, Equifax and Callcredit. Each bureau uses their own data sets to define your credit score. If your credit history is the same, why would a credit score vary? There are two reasons:
- Creditors can choose whether to report data to one or more bureaus. That means it’s very possible that not every bureau has the same information, causing them to score you differently.
- Each bureau has a different scale, so the numbers are independent within their own scale. For example, Callcredit’s scale goes up to 800 while Experian’s scale goes up to 999.
Why do you need a credit score?
When you apply for credit, the lender needs to understand your credit history, among other things, to determine if you are able to repay the amount you are requesting. Your credit score is used for things like credit card applications, flat leases, car financing, mobile phone contracts, personal loans and more. If you do not have a good credit score, you might find it challenging to get the approval needed for the above necessities.
What goes into a credit score?
Your credit score is based off of a compilation of your credit history, commonly called a credit report. There are many factors that are included on this report, including the following:
- Current debt balance compared to your credit limit. For example, if you have £500 of credit debt and your credit limit is £10,000, your credit score will not be harmed much by the balance (5% of your credit). If you had the same balance of debt but only £1,000, or 50% of your available credit, that may negatively impact your score.
- Late or missed payments. If you have ever been truant with a payment, it will show up on your report and continue to negatively impact your score for six years. At that point, it is removed and no longer affects your score, but you can see how important it is not to make this simple mistake.
- Length of your credit history. The longer your credit history, the better. A longer credit history allows a lender to see loans you’ve paid off successfully, an indication of consistency over long periods of time.
- Diverse credit history. Lenders appreciate seeing a variety of credit options to show that no matter the circumstance, you’re a reliable person. If someone only has several lines of credit or a long list of instalment loans, it won’t discredit you, but it doesn’t help improve your score.
- Bankruptcies and other major financial filings. Negative financial events will get logged on your credit report and act as red flags to lenders. Know that these will have a major impact on your score, and you won’t always get the chance to explain the circumstances of these types of events.
- Credit enquires. If you are constantly asking for credit, it serves as a red flag to potential lenders. They may see the frequent enquiries as a sign that you are frequently in need and don’t get approved — thus why you keep “asking” and have your credit checked.
How do I improve my credit score?
If you are frequently getting denied credit access, or if you are challenged by high interest rates, it’s time you took a hard look at your credit history and reflect on areas to improve. Give creditors a reason to believe in you and your ability to repay your debts. Here are a few ways to address your low score and improve it quickly:
- Get on the electoral roll and prove where you live. This is a simple way to verify you live where you say you live, making it easier for lenders to confirm your identity.
- Work on paying off your current debt to free up your credit limit. Generally, you should be using up less than 30% of your rolling credit at any time. If you maintain a balance over a long period of time without paying it down, it will eventually start to harm your credit.
- Make sure you never miss a payment. Set up automatic bill pay or calendar reminders to help you stay on track.
- Avoid making multiple credit enquiries if you can. Focus on paying on the debt you already have rather than opening up new lines of credit.
- Don’t close out old accounts. As your accounts grow older, so will your credit history, which will effectively raise your score over time.