For better or worse, debt is an integral part of our modern society. A mortgage, a loan or even your credit card are a form of debt, since you receive credit now, and have to pay it back later. But in order to receive credit, you must first prove your creditworthiness to the lender and this is achieved through something known as a credit score.
What is a credit score? 💯
A credit score is essentially a number that describes a person’s creditworthiness or, simply put, it gives a good indication of a person’s historic repayment performance and the likelihood of them repaying their debts in the future.
You can think of a credit score as the grade you received on a school report. 📓
Your credit score is a number provided to you on request by one or more credit reference agencies. Although this score tells you how likely you are to be accepted for a credit product offered by a potential lender, many lenders assess your creditworthiness based on a range of criteria, not just by your credit score alone.
This is all very interesting, but how does it affect me? 🤔
Credit scores are used by virtually every company who issues debt - this can be in the form of a personal loan, a mortgage or any financing plan. This means that your acceptance to most type of finance plans for purchasing goods and services will be influenced by your credit score. 📈
In short, a higher score is considered a good score and usually translates to getting better deals, rates and repayment terms, while a lower score (a bad credit score) brings less favorable terms and, in some cases, can result in you being rejected from a financing plan altogether.
You have my full attention. How is a credit score calculated? 🔮
Credit scores are calculated based on the information included in a person’s credit report.
If your credit score is like a grade on your report at school, you can think of a credit report as the whole school report - one that contains information about the money you borrowed and how you paid it back. 📑
Credit reports are calculated and compiled by credit reference agencies. They contain information gathered from entities that have had financial dealings with you - such as banks, lenders, utility companies and internet or phone providers.
What is a credit reference agency? 🏛
Credit reference agencies are specially licensed private institutions that collect information about your credit history from lenders and use it to create credit reports. These reports help companies reach a decision on whether to offer you credit (ie. give you a loan).
In the UK, there are three credit reference agencies - Experian, Equifax and Callcredit. 🇬🇧
More importantly, whenever a company requests to see your credit report and score (also known as a hard search), this action gets recorded on your report. Applying for multiple credit cards around the same time, for example, can have a negative impact on your overall score, but as long as you meet your repayments the impact will only be short term.
What information is included in a credit report? ✅
- Personal information including name, date of birth, current address
- Previous addresses from the last 6 years
- Financial associations - joint accounts
- Electoral roll status - whether you’re registered to vote at your address
- Current accounts - usually your overdraft limits
- Credit accounts - credit cards, loans (repayment history, limits, monthly usage)
- External requests to access your credit report
- Fraudulent activity
- Payment history - how you’ve paid back your debts, and your limit usage
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What information is excluded from a credit report? ⛔
- Savings accounts
- Student loans
- Parking or driving fines
- Criminal record
- Medical history
- Gender or ethnicity
What is a good credit score and how can I check mine? 🔍
Everyone is entitled to see their credit score and this can be done by contacting the credit reference agencies. It is always worth checking with all three agencies, since each one will have their own internal policy (usually kept confidential) on how these scores are worked out. What’s more, the range of a credit score differs from one agency to another:
As you can see, each agency provides a different score, which makes comparisons between them a virtually impossible task. That said, each agency is obliged to provide you with a statutory credit report within 7 days of your application. These reports currently cost just £2 per application, so by spending £6 in total, you can be in a good place to start improving your score.
I’ve checked my credit score, but how can I improve it? 😬
These are just some of the ways in which you can improve your credit score:
- Open a UK bank account
- Register to vote
- Ask for an overdraft
- Get a credit card
- Pay household utility bills in your name
- Consider credit builder products
The important thing to consider is to never borrow more than you can pay back (50% of your available credit is usually ideal) and to always make sure you pay back your debts on time.
I’m more at ease now, but how accurate is a credit score? 🤔
Earlier in the article we talked about the information that goes into a credit report as well as what is omitted.
Credit reference agencies only collect static data points, as we’ve shown in the list above. Therefore, these agencies miss out some essential bits of information that show how much you can actually afford to borrow. This is because details such as the amount of funds going in and out of your accounts, your investments, savings and more are not visible to the credit reference agencies under current regulations. 🕳
In a sense, these institutions currently have a somewhat skewed view of your financial life (this is why your ‘data self’ is slightly different to the real you).
But will they get more accurate? 💡
Earlier this year, a new type of pan-european regulation came into effect, under the name of PSD 2 (the Second Payments Services Directive).
This new set of laws, once fully implemented, will allow financial institutions, including credit reference agencies, to connect directly to your bank accounts for example, through the Open Banking API (a common language that connects many different financial institutions) and pull aggregated transaction data with your consent. 🏦
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This will allow credit agencies to analyze your data in a more dynamic way, giving them a much clearer picture of your financial habits, which should be reflected in your credit score. Therefore, with this enriched stream of data, you could get better terms on your loan, receive favourable rates on a mortgage, or have more goodies bundled in with your credit card.
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