Monday

What is a credit score?

What you pay for a mortgage, your car insurance, even your mobile phone contract, most likely depends on three-digits you probably don't even know…


 
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Do these words follow you whenever you apply for credit cards, or try to get car insurance? How about when you apply for home loan or car loan? Are you having nightmares about your financial future trying to understand a three-digit number called credit score and how it is calculated?

Well, let us start by telling you that your credit score is something that can either cost or save you thousands of pounds. However for that to happen, you must understand the ‘what’, ‘where’ and ‘how’ of a credit score. Read on…

What is a credit score?
Say you are planning to buy a home, and for that you approach a bank for loan. As a responsible lender, the bank would want to make sure that you can comfortably afford to manage any new borrowing. Of course, they would also try to make some money off of you. To do so, they would need to evaluate all the relevant information regarding your financial behaviour at their disposal. This is where the credit score comes in. It provides them with all your credit history and helps them to assess the chances that you will be able to repay what you owe.

Simply put, a credit score is a tool used by banks to determine your eligibility for credit cards and loans and by insurance companies to determine if you are a good credit risk. Most of the times, landlords and potential employers also take this information into account, while finalising a probable candidate. Hence, if there is any three-digit numbers that hold so much power, it is this number.
Divided into categories, ranging from very poor (0-560) to fair (721-880) to excellent (961-999), your credit score defines your financial worthiness. People with a high score are generally seen as lower risk, and are therefore more likely to be granted credit - and most likely at better rates.

How is it calculated?  
Contrary to popular notion, your personal or professional information such as age, race, marital status, income and employment don't affect the score. However, there are a number of key components that can either make or break your credit score. Here are the five major ones:

Payment history: Making payments boosts your score, while missing payments destroys it.
Amounts owed: Debt can hurt your score, though installment loans (like student loans) are actually beneficial if you keep up with your payments.

Length of credit history: Old accounts earn more trust, whereas new accounts are regarded with suspicion. This means that a late payment on a two-year-old account will hurt your score more than if you’d had the card for two decades.
Types of credit used: Different kinds of credit impact your score in different ways. For instance, a credit card from a national bank carries more weight than one from a department store.

New credit: Multiple requests for credit, including credit inquiries and number of recently opened accounts in a short period of time mean you are a greater risk.
Apart from this, your electoral roll information and court records are also taken into account while calculating your credit score.

There are three major credit bureaus in UK - Equifax, Experian and CallCredit - which issue credit scores. These commercial organisations compile all information about you and supply that to a lender when you apply for credit. Since each pulls information from a slightly different network of lenders to compile its own report, the scores mostly vary from bureau to bureau.

Where can I find my credit score?
You have a statutory right to get your credit report from each of the three major credit bureaus, each year, for a nominal fee of £2. You can even opt for a free 30-day trial with either Equifax or Experian and check your credit score online. Bookmark these links for future use:




Useful advice
With identity theft becoming the buzz word in today’s Digital age, you should check your credit report regularly and report inconsistencies immediately. Elements on your credit report that don’t belong to you or mistakes such as wrong name or an old address, happen more often than you might think and can have adverse effects on your credit score.

While applying for loans or insurance, your score can mean the difference between a reasonable or outrageous interest rate, as well as the difference between an affordable or unbearable insurance rate, so take it very seriously.
Always check your credit report/ score after rejection so that you don’t fall into the nightmare scenario of the rejection spiral. Once rejected, go through your report carefully for errors and get them corrected, else you will be vetoed, again, not because of any error, but because of ‘recent searches’. 

Even though a credit score is derived from your financial history, it works towards predicting your future financial behaviour. So while, a poor history counts against you, having little or no credit history is equally bad, as it makes predictions less certain.
Never pay for a credit repair company. If you see these advertised, avoid them. If you are struggling and need personalised, professional help, see a non-profit debt counselling agency like Citizens Advice Bureau, Civil Legal Advice or StepChange Debt Charity.

And finally, instead of obsessing about your credit score, understand that good spending will be rewarded and bad spending will be penalised. Be logical, sometimes frugal and be smart. Learn the important elements – such as pay on time, keep your debts low, eliminate discrepancies and stick with your old bank and credit cards – and develop habits that will keep your credit score high for years to come. It is that simple.