You Need This to Borrow Money: Credit Scores

What is your credit score?

In short, your credit score is quite a big deal. It can open many doors for you, whether it’s buying a house, financing a car, or applying for a new credit card. For instance, if you’re hoping to secure your first property, you may need a loan to finance it. When you apply for the loan (credit), your potential lender will evaluate how big a risk you pose as a borrower (i.e. the likelihood of being late with repayments or not paying them back). The lender will ask what your credit score is. In other words, you need a credit score to borrow money.

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A credit score is a tool often used in deciding how likely it is that you’ll pay the lender back as agreed. Globally, your credit score is usually a 3 or 4 digit number based on your credit report. The methods and criteria behind the scoring tend to be secret, as no company wishes to disclose the exact algorithms they use to competitors. What we do know is that the higher your score, the better! 

Changes to your score can have a significant impact on your life. A good credit score indicates that you are paying your bills on time and likely to pay lenders back. As a result, you can benefit from lower than average interest rates, credit card approval, and personal, business, or student loans. Over the years, this could save you thousands of dollars. However, a poor credit score will mean your credit options are limited and more expensive.

Credit reports and worthiness

Every country has a list of authorised credit reporting agencies that can issue credit reports and credit scores. Your credit report contains information relevant to deciding your credit score and is distributable to banks, credit card companies, finance companies or yourself upon request.

The impact of your credit report can go beyond financial implications. Your credit report can also impact your level of employability, which may come as a surprise. Businesses are increasingly likely to use your credit report as a judgement of how responsible you are. A bad credit report indicates that you are irresponsible. 

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Credit bureaus keep track of credit reports and receive information from their members, storing information such as:

  • Basic personal information
  • Credit check history
  • Credit card applications
  • Credit repayment records, including late payments on credit cards
  • Bankruptcy records, which are removable if debts are repaid. Otherwise, records are disclosed for 5 years from the date of discharge
  • Default records

Based on these factors, the local credit bureau, for example, Experian in the US, gives a credit score for each person. 

How to maximise your credit score

Make payments on time. Making your payments on time and in full demonstrates that you are a responsible borrower. Making payments on time is not only for loans – but all your phone and utility bills, rent and medical bills. Altogether, these typically impact your credit score more than any other information in your credit report. Not only will late loan payments affect your credit score, but they will come at a charge (interest), known as APR.

As such, take note of your repayment dates and ensure you have enough money to pay each of them ahead of those dates! A recurring entry in your phone calendar would help keep track.

Credit utilisation – the ratio of debt to your credit. This is the second most influential of the credit-score factors. Working down your credit card balance to a low utilisation score will improve your credit score. Ideally, you should aim for a debt-to-credit limit ratio between 0 to 20%. For example, if you have a card with a $1,000 limit and a $200 balance, your utilisation rate is 20%. 

Although a ratio of 1 to 20% is excellent, it should go without saying that the ideal credit utilisation scenario is to have all debt paid off! There are zero benefits to either your score or financial health of rolling over a loan balance – a total myth! 

TOP TIP! You shouldn’t cancel your cards or other credit lines once they are paid off (unless you pay fees). This decreases the credit available to you, worsening your debt-to-credit limit ratio. As a result, you could find yourself paying off credit cards but seeing your credit score lower. 

Length of credit history. Data shows that consumers with longer credit histories are less risky borrowers. As such, think twice before closing the accounts of old credit cards in your wallet or opening numerous new lines of credit. Both of these actions will lower the average age of your credit lines. You can keep your older credit lines active by making small purchases every now and then (and paying them off quickly).

Number of credit lines. Try limiting the number of credit lines you have open. This includes mortgages, car loans, credit cards, education, and personal loans. Also, put a limit in place for manageability purposes. Keeping on top of your credit becomes much easier when you only have a couple of credit cards. Trying to access a lot of credit in a short space of time signals a risky lender to the potential borrower.

Have a sensible state of mind when dealing with credit. Put in the work to maintain a clean credit report, but don’t open new lines of credit to boost your score. Do not become obsessed with your credit score, as you’ll become distracted from achieving other financial goals.

Any default and bankruptcy proceedings are permanently displayed in your credit report, so be aware of this before you start opening credit lines. You can find these details stated as a statistic on your credit report.

The factors listed above revolve around good financial behaviour. Paying bills on time, not spending more than you earn, and having a sensible approach are all stances to benefit your finances, regardless of whether it’s on credit or not. 

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On top of the factors already discussed, here are a few others that don’t matter to your credit score – but may affect your ability to obtain credit:

  1. Employment history – Where and how long you have been working does not impact your credit score. Some creditors will have employment requirements, but your employment history does not affect your score directly.
  1. Interest rates on debt – It is essential to pay off debt, but the interest rate itself is not a factor that will come up in your credit report.
  1. Savings account balance – You may be relieved to know that your bank balance is not recorded as part of your credit history! After all, bad credit scores are not exclusive to people who struggle financially.
  1. Your age – Credit scores do not discriminate by age, though obviously, there is an impact regarding the length of your credit history.
  1. Your location – You can live anywhere and have a good credit score. Although your credit history may not follow you abroad, your debt will! 

Regarding credit scores, it’s best to check your credit reports and scores regularly. If you wish to check your credit report, you can do so with local credit bureaus. 

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