If you spend any time reading about how to improve your financial situation, or get yourself out of debt etc., you will probably have come across the term "credit score" a countless number of times in your readings. When I first reading up more about personal finance I found it to be a pretty pervasive term right from the start, and something that seemed to come into play in a whole range of situations; from clearing credit card debt, to buying your first home, to getting a personal loan at the bank.
Now, on the surface, the term "credit score" seems pretty self explanatory, but there are a few things that are worth getting some clarity on when it comes to understanding the full meaning of what a ‘credit score’ really is.
What is my credit score?
It’s essentially a mathematical equation they use to mitigate risk and discern whether you are going to repay them the money you intend to borrow, based on your behaviour in the past.
Contrary to popular belief, there isn’t one universal credit score attached to you and your borrowing behaviours. Each lender has it’s own algorithm and way of calculating it’s score for you.
How do I get a bad or good credit score?
As you’d expect, having a bad credit history where you have defaulted on loans or not paid back credit card debt, will earn you a “bad credit score”. Ie. it makes you a risk for the lender because you have not paid back money in the past, therefore it is likely that you will not pay back the money you are asking for now.
A "good credit score" comes from having a good credit history where you have not defaulted on debt or loan payments, and are therefore a low risk option for the lender.
There are a few important things to note however…
If you have very little or no debt history, because you’ve tried to be sensible and stay away from credit, then this could have an adverse effect on your credit rating because banks can’t get a read on your behaviour. It means that you could be turned down for a loan because there isn’t enough “data” on your borrowing behaviour.
Additionally, just because you have a bad credit rating, it doesn’t always mean you won’t get given a loan or credit card. There are many companies that do specialise in lending to people with bad credit scores, such as Amigo Loans. It means that just because you have bad credit history the world isn’t a financial wasteland for you, but the loans and credit services offered by these companies usually have much higher APR’s, designed to mitigate the risk that comes from lending to “less sure” candidates.
Does a bad score last forever?
Luckily for yours truly here, no they do not. Things like missed payment or county court judgements (CCJs) stay on your report for about 6 years before they “fall off” and are no longer counted.
It’s also worth noting that if you have a credit card that has been closed in good standing (ie. no late or missed payments) then that will also stay on your report for 6 years before it too falls off and is no longer counted. It’s why sometimes people advise you against closing your credit card account for no reason, as you will lose it as a source of good credit history.
How can I improve my score?
As I’m sure you’ve guessed by now, the only way to really improve your credit score is to start paying off your loans in a reliable way. Make sure your payments are always on time, and that you work to reduce high balances on any credit cards that you have.
In addition to this, don’t open new cards or take out more loans in order to cover your old debt. This leads to a debt cycle that will only harm your credit score, and risk putting you in a dangerous financial position.
Increasing credit rating is not an overnight process. It’s about changing your patterns of behaviour so that lenders can see you have become a reliable borrower. Just take heart from the fact that the further away they get, the less of an impact missed or late payments have on your credit score. It just take a little time.
Although in the UK we are not taught enough about personal finance or the financial system when we are at school, it doesn’t have to be something that is forever shrouded in myth and legend. There are great websites that explain these things very clearly and concisely in order to help you get a clearer understanding of things like credit scores and debt management. There’s a cool little quiz you can take on Experian that lets you know how much you really understand about credit scores, and the Money Advice Service is always super helpful on anything finance related.
If you are thinking about getting a credit card for the first time in order to improve your credit history, then read our piece Credit Card 101, about what you should take into consideration when getting your first card.