How does a credit score work and what can affect it? Understand your position and how you can improve it.
A Guide to Understanding Credit Scores
What is a Credit Score?
Your credit score is a number given to you that reflects the likelihood of you paying back borrowed money.
Your credit score is made up of several factors:
- Your current amount of debt
- Details of unpaid debt
- Details of any defaults
- The amount of any available debt
Your credit score plays an important role in determining whether or not lenders will allow you to borrow money and which financial products you can take out. It will also determine whether you get the best interest rates when applying for a credit card, loan or mortgage.
What Affects Your Credit Score?
Your credit score is determined by a combination of a number of factors. It’s important to understand what impacts your credit score so that you can keep it as healthy as possible. Different lenders have different criteria as to what they will apply based on the score, so you are not always guaranteed to be accepted if you apply for credit even if your score seems good.
Some of the factors that influence your credit score are:
- Your credit limit – a higher credit limit can indicate to other lenders that you are low risk as a borrower. A lower credit limit may be given if you are determined to be a higher risk borrower
- Payment history – poor payment history can impact your score. Any payment defaults registered will stay on your credit file for 6 years
- Credit utilisation – If you have reached the maximum amount of credit on all of your accounts this can show that you are heavily reliant on credit Lower utilisation shows that you can manage your finances without relying on credit
- New accounts – opening lots of new accounts in a short space of time may show that you need new streams of credit. It’s best to try to only open one or two new accounts within 6 months if you can
- Age of credit – if a creditor can see that you have been managing credit for a long period, this can help improve your credit score
How to Check Your Credit Score
No matter what your financial circumstances are, it’s always wise to keep a close eye on your credit score. There are several free places to check your credit score, but the three main credit-reference agencies in the UK also provide a free credit score option.
These agencies are:
What Is Considered a Good or Bad Credit Score?
A credit score tends to be between 350 and 850. The higher your credit score, the more likely you will be accepted for credit — possibly with a lower interest rate. Having said that, having a lower credit score isn’t necessarily a bad thing if you can manage your credit and can pay your bills without needing any more credit.
Who Will Check Your Credit Score?
Your credit score is a part of your personal information, and other people should only be able to access it if they have a very good reason to.
Companies that may check your credit score include:
- Mortgage providers and letting agents
- Creditors and lenders
- Potential employers
- Utility, service and insurance companies
- Debt-collection agencies
How to Improve Your Credit Score
If you have a credit score that is lower than you’d like it to be, there are ways that you can improve it. One of the best ways to do this is to pay your bills and creditors on time and in full accordance with your agreement with the lender. Positive payment history is the most important factor in most credit scoring models.
Another way of improving your credit score is to only apply for and open credit accounts when you need to and only if you can make payments in full and on time. This will help to have a positive impact on your credit score.
How Will Entering into a Debt Solution Affect Your Credit Score?
When you enter into any debt solution – a Debt Management Plan, Individual Voluntary Arrangement, Debt Relief Order or Bankruptcy, you will no longer be making the minimal contractual payments towards your creditors. This means that they will register a default on your credit file. Defaults stay on your credit file for 6 years.
However, the likelihood is that you may have already made late payments and had defaults registered on your credit file that have negatively affected your credit score for a while.