Most of us will have, at some time or another, had our credit rating checked. Not necessarily only when applying for a personal bank loan or mortgage, though an applicant’s credit rating is always referred to during those processes. Your credit rating will be looked at if you take out a phone contract that includes paying off a new smartphone over a period of time because that counts as you buying the phone on credit.
If you don’t keep paying your contract until it finishes, the operator will lose out on the cost of the smartphone they’ve paid for upfront and then sold on to you. So they want to make sure there is a good chance you’ll stick to your contract. The same principle applies if you want to take a loan or credit for a higher value. The lender relies on the borrower’s credit rating to judge how likely they are to pay back credit or a loan and to make instalments on time.
Simply opening a current account with a bank now usually involves a credit score check, even if you are not asking for an overdraft or any other kind of loan or credit facility. The fact of the matter is your credit score is an integral part of modern life in the UK. It comes into play when you use even the most basic of financial services.
Companies offering credit on consumer products or loans want to avoid having to spend time individually assessing each applicant. So they rely on the credit ratings of one or more of the three main UK credit bureaus – Equifax, Experian and TransUnion. In the UK, the credit rating bureaus confirm a person’s identity, and associate credit history, through the information on them held with the electoral resister. So being registered to vote is absolutely key to being able to start to build a credit rating!
How Is My Credit Rating Calculated?
An individual’s credit score is a three figure number awarded on a points system. Points are added and subtracted based on your credit history. And credit history is a combination of your payment history for two main kinds of credit:
Instalment credit – loans for a fixed amount where the principal plus contracted interest rate is paid off in regular instalments, usually monthly, over the agreed period of time. Common examples of instalment credit would be student and personal loans or a mortgage.
Revolving credit –a credit facility with a limit you can make use of and pay off as convenient, as long as minimum monthly instalments are made. Revolving credit would most commonly mean credit card balances but can include other specialist finance products like some kinds of home equity loans.
There are many different influences on a credit rating but Experian lists the five most important as:
- Payment history – Experian says this is the single most important influence on a credit rating, accounting for up to 35% of the total score. Basically, this means making any due credit payments on time. As little as one missed or late payment is likely to have a negative impact on a credit rating.
- Credit limits use – almost as important as payment history is how much of a person’s revolving credit limits they make use of at any one time – the ‘credit utilisation ratio’. Experian says this adds up to 30% of a credit rating. Ratings agencies consider it a negative if more than 30% of revolving credit limits are used as this indicates to them a reliance on credit funds.
- Credit mix – credit rating models look at the kinds of credit accounts an individual has and has had in the past as well as how many at any one time. This gives them an indication on how well the person manages debt. Not having had many different loans or different kinds of loans shouldn’t bring your credit rating down. But having a history of a diverse mix of different kinds of credit, as long as payments have been made on time, can boost a credit rating and Experian says it can count for up to 10%.
- Hard enquiries – hard enquiries are added to someone’s credit rating file every time a lender requests their credit rating. These requests usually sit on file for up to two years and can possibly have a negative impact on a credit rating if it is considered a lot have been made.
- Negative information – any late or missed payments but also bad debts such as foreclosures or collection accounts count as negative information. These entries usually stay as part of your credit history for at least seven years and can really drag down a credit rating.
How Can I Improve My Credit Rating?
Improving a credit rating really just involves keeping in mind the five most important contributors to it listed above and sticking to them better than you have done, if that’s practically possible.
- Make sure you make payments on any credit you already have on time.
- Pay down revolving credit to below 30% of your limits as quickly as possible.
- Try to create a mix of different kinds of credit used over the years without ever borrowing too much.
- Don’t apply for credit often.
- Avoid defaulting on any credit you do take at all costs.
Stick to the above and when you do need to make use of credit, you shouldn’t have any issues being approved for it as long as instalments are manageable as a percentage of your regular income.