What is Credit and Why Does it Matter?

Nearly 4 in 5 adults hold at least one credit or loan product, according to the FCA Financial Lives Survey.

It’s highly likely then that you’re aware of the term “credit”. But has anyone ever taken the time to explain exactly what it means? No? Let’s change that.

Credit is a vital part of your financial health because it enables you to borrow money or access goods or services with the agreement that you will pay back later. You are granted credit by lenders, service providers and merchants (a.k.a creditors) if they are confident that you can pay back what’s borrowed, plus any extra charges.

Creditors calculate your credit score to determine if you’re eligible to borrow. In other words, they want to know if you have “good credit”.

What is a good credit score?

A high credit score equals lower risk, which is why the higher your score is, the better. It’s what you want to aim for to increase your chances of securing loans, credit cards or mortgages.

A good credit score also means you could be offered better rates and deals, potentially saving you thousands of pounds. For example, the credit reference agency Experian explains how:

“A 30-year fixed mortgage of £250,000 at 5.5% will cost a borrower a total of £511,010 over the lifetime of the loan. If that same borrower can get a 4.5% interest rate—just one percentage point lower—she will pay £456,017 over the life of the loan, a difference of £54,993.”

How is a credit score calculated?

UK lenders calculate your credit score by looking at any past dealings they may have had with you and the information held on your credit file, such as your:

●      payment history from the past six years

●      financial associations (a person you’ve applied for a joint credit agreement with, like a joint bank account or mortgage)

●      other credit applications

●      electoral roll status (this provides evidence that your most recent address is still your current one, so if money does have to be recovered, lenders know where to start)

●      court information (lenders will look for County Court judgment or insolvency which can severely impact your creditworthiness)

The information on your credit file comes from the three credit reference agencies in the UK – Experian and Equifax. A lender can consult one or more of them when calculating your score.

Experian and Equifax all have their own credit score ranges. They are as follows:

Experian

Equifax

While lenders can get certain information from Experian and Equifax, the score they provide you on request is only visible to you. It is not shared with lenders – they must calculate their own credit score for you when reviewing your application.

Lenders don’t disclose how they calculate scores, making the system difficult to crack. The Financial Conduct Authority is reviewing the market in an attempt to make it clearer for customers.

It will show “whether vulnerable customers are disproportionately affected by the way credit information is used, and whether any alternative approaches might deliver better outcomes for consumers.” You can follow any updates on the FCA’s site.

How to improve your credit score

How you go about improving your credit score depends on what financial product you’re looking to acquire. That’s because credit card companies, banks and mortgage lenders look at different things when calculating your score. For example, mortgage lenders might look at your:

●      Recent applications: a high amount of applications may equate to higher levels of risk, although not always

●      Payment history: lenders may review your payment history on credit cards, loans, etc. to make sure you have a good track record of on-time payments, demonstrating that you’ll make a responsible borrower

●      Major derogatories: such as bankruptcies, accounts past due, account in collections, etc.

Whereas credit card companies typically look at your:

●      Credit card utilisation rate: this reflects how much you currently owe on your existing cards divided by your credit limit. It is recommended to keep your total credit utilization rate below 30%.

●      Number of delinquencies: a fancy term for any account past due. You should know that a late payment can stay on your credit report for up to seven years from when it occurred.

●      Hard inquiries: this happens when a credit card issuer checks your credit when deciding whether to approve your application. Too many hard inquiries can damage your creditworthiness since it can indicate that you’re opening lots of accounts because you’re low on cash.

Researching what information different lenders look at when you apply for credit helps you avoid activities that can damage your creditworthiness.

For example, if you want to get the best deal on a credit card, you need to make sure you keep on top of credit card payments. Cancelling old cards is a good idea too. They can cause a lender to see you as someone who doesn’t use credit often, making you less of an available candidate for borrowing.

For 10 ways to improve your credit score, check out our blog here.

What else is a credit score used for?

We’ve already covered the basics – mortgage lenders, credit card companies and banks primarily use your credit score to calculate your risk as a borrower. But who else uses your credit score and what for?

Sometimes employers will check a candidate’s credit score when considering their application (a recent survey by The National Association of Professional Background Screeners showed that 25% of the HR professionals use credit or financial checks while hiring for some positions, while 6% check the credit of all applicants).

They look out for signs of financial distress that might indicate risk of theft or fraud, such as:

●      Lots of late payments

●      Excessive debt

●      Any evidence of mishandling finances

Some landlords also check the credit scores of potential tenants to see if they’ve had issues paying bills in the past. They need permission to do this from the tenant first.

Mobile phone, car insurance and utility companies may also do a credit check for the same reason – they want evidence that you can pay your bills on time and are therefore a trustworthy customer.

We want you to feel good about your credit score, which is why we want you know where you can check your credit score for free here.

Also, if there are any questions we haven’t answered in this blog, feel free to give us a call on 0161 486 1777 or send us an email to info@gmbcreditunion.com.