This is an essentialist guide to credit score. You will learn what is a credit score, who uses it for what decisions, and what can you do to improve your credit report.
I may be the only personal finance blogger who had absolutely no idea what is her credit score.
And why should I?
I have never been refused credit. (Okay, I was refused a zero percent credit card when we were just starting to pay off our debt but then I had no job applying for one given the amount of debt we had anyway.)
Lenders compete for my custom and bombard me with letters, phone calls, and juicy zero percent transfer offers.
So, you see, there was absolutely no reason for me to check my credit score – it wasn’t a problem.
Credit scores were something about which other people worry.
Until I started writing something that made me look into the matter. I checked my credit score and on Experian it is…
…a perfect 999.
This is probably the highest credit score one could get! No wonder these offers of credit keep streaming into my house.
Then something caught my attention.
It is all good and proper that I have this high credit score but most of my credit cards didn’t appear on the credit report. Which made me curious to learn more about the credit score game and all that goes with it.
This is what I found and it’s essential that you know about it as well.
What is a credit score?
Your credit score is a number calculated using a variety of sources of information. I couldn’t find the exact formula – and different credit companies and lenders use different algorithms – but it is mostly based on your credit report (your credit history), confirmation of your identity, all information that you may find on credit applications like your income, debt level, reasons for borrowing, etc. and information about your past relationship with the lander.
Your credit score tells lenders how much of a risk you are if they lend you money.
I’m not sure what came first – the credit report and score companies like Experian and Equifax and many others – or the erosion of personal relationships in banking and finance.
I still feel nostalgic about the personal service we used to get by our bank. Going to see our bank manager was the second thing John and I did after we got married (I hope you are not going to ask what was the first one because I’ll have to tell you we went to walk the dog).
John told him about our plans, he looked at me and said: ‘It all depends on whether you are an asset or a liability.’
It turned out that I’m an asset. But our trusted personal bank manager is long retired and I’ve never met the new one – we exchange e-mails if we are lucky.
Here comes the credit score.
Since your relationship with your bank – and other financial organisations – is impersonal they have no way of knowing whether you are a worthy risk or not except by using a number assigned to your name.
As Johnny Cash sings ‘I’m just a number, Lord, oh Lord’. (Okay, he was singing about being in prison but…).
A whole industry around collecting, collating, and providing information about your credit history – and calculating your credit score – emerged.
And it has, as I discovered, a lot of power over our lives.
Who uses credit scores?
While I was chatting with the good people from Experian, and several other personal finance bloggers, it dawned on me that this credit score thing that I’ve been totally ignoring is far more important than I thought.
I didn’t realise how important it is because it’s never been a problem for me. Remember the perfectly high score I mentioned before?
But the lady who does some cleaning and ironing for me mentioned the other day that she had to pay a bit more for her carpet because it came from a place that did not check your credit score. Madness, right? People who have less money, are likely to have a lower credit score and they pay more for goods and services – a vicious circle if I’ve seen one.
Here are some instances where your credit score is important.
- When you get a mortgage (or re-mortgage). There are no two ways about it: if your credit score is poor your mortgage application will be rejected. And having a poor credit score doesn’t only mean that you have too much debt and have defaulted on payments in the past. It can also mean that you have no credit history; that you’ve never borrowed money and/or had credit cards. Yep, there are such people around – a close colleague of mine had a really hard job getting a mortgage exactly because he’d always had savings and had never borrowed or had credit cards. Conversely, if you have a credit score of 999 you can have a mortgage at 1.5% interest (and I’m exaggerating only very slightly).
- Credit cards. If your credit score is on the wrong side of good you don’t stand a chance of getting a 0% credit card and/or any of the deals.
- Loans. Just like with the mortgages, your credit score matters not only regarding acceptance but also affects the rate of interest you’ll be paying.
- Energy bills. If you fail an energy provider’s credit score threshold you are likely to be asked for a deposit; also, they may not offer their best tariffs.
- All kinds of insurers. Insurers check our credit score when you choose to pay monthly; and if you don’t meet the required level, you may be put on a higher rate.
- Mobile phones. You are credit scored if you are getting a contract mobile phone.
- Landlords. When I was looking for rented accommodation several decades ago, all my landlord wanted was testimonials as to my character; now this was really easy. Today, landlords check your credit score and this can decide whether they agree to rent you the property as well as how much deposit they are going to charge.
- Some shops.
You see, credit scores are used widely to assess the level of financial risk you present.
How can you use your credit score?
What you can use your credit score for depends on how good it is. If your credit score is good you can use it to get all services and facilities mentioned in the previous part of this guide.
If your credit score is perfect, you can brag about it; though, I’m far from certain that ‘Hi, babe. Do you want to see my credit score?’ is a chat-up line that will get you a date.
If your credit score is between average and hopeless, you’ll need to focus on improving it. Otherwise, you’ll have to make sure you can buy your home for cash, you never need to borrow any money and you buy your mobile phones outright.
What you can’t use your credit score for?
There are many things you can’t use your credit score for.
What is important to remember here is that credit score companies are not perfect and that credit reports are not perfect either.
I checked my credit report because I read once too many times that it is a good way to take stock of all your debts.
Let’s try this one, I thought. I registered on Experian, I got my credit report and my credit score. And you know what?
Half of my credit cards were not included in the credit report. You can’t use your credit report to make an inventory of all your debt: some of it won’t be included.
As is the case, there is a very good reason for that. All credit cards issued before a certain date (I think it is before 1999) don’t appear on the credit report because you haven’t signed an agreement for that at the moment of issue.
If you want them included you have to authorise the issuer to provide the information to the credit report/score company.
How to check your credit score?
You can check your credit report and credit score using one of a number of companies that have entered this niche.
Just get on and follow the instructions: usually getting your credit report and credit score is really easy and takes no time at all.
When you are checking your credit report and score watch the charges: the service isn’t normally free and there are different payment models. And if you use one of the ‘free’ introductory offers, please make sure you don’t forget to cancel it if you don’t intend to check your score every hour or so.
How to improve your credit score?
There is a lot written on how to improve your credit score.
John has a friend – a statistician – who has done some research on credit scores. He claims that there are two factors that affect it most: a) whether you are on the voting register; and b) whether you have a mortgage.
Here come thirteen ways to improve your credit score:
#1. Register to vote (this is also good for democracy).
#2. Get a mortgage.
#3. Have a credit card; use it and pay it in full (this way you’ll not end up in debt).
#4. Spread your debt. This came up as a bit of a surprise to me but what really kills your credit score is not the total amount of your debt (though some lenders may look at that as well). What affects your score negatively is whether your credit cards are maxed out.
#5. Don’t close your credit cards; if you decide not to use them just not use them. (There is a school in personal finance that will advise to close them.)
#6. Use different sources of credit.
#7. Don’t ever miss a payment; any payment.
#8. Pay all your bills on time.
#9. Don’t apply for more credit cards if you may be rejected.
#10. Don’t withdraw cash on credit cards.
#11. Don’t play around with payday loans.
#12. Reduce your debt.
#13. Pay for insurance in one annual payment (house and car).
Six things you shouldn’t believe about your credit score?
Now that you know what credit scores are and how they are used, let me tell you about the myths that have developed around the industry.
Here are the six main things you shouldn’t believe:
#1. Credit reference agencies make decisions. They don’t; they just collect, keep, and provide information.
#2. There is a credit score blacklist. This is like it’s come from the darkest of the conspiracy theory minds.
#3. The credit score of the previous occupants of your accommodation reflects on yours. Not true.
#4. Past debts don’t count. Well, they do.
#5. Friends and family living in your house affect your credit score. They don’t.
#6. Entries on your credit history are there forever. No; they are kept for six years.
This is The Money Principle essentialist guide to credit score that everyone needs to follow – understanding how decisions about your creditworthiness are reached, and how to affect these, can change your life.
Because credit scores are important and are not likely to go away.
This doesn’t mean that I’ll be checking my credit score as often as the stats of The Money Principle (which is often) but I intend to do it at least once a year.
How about you? When was the last time you checked your credit score and what was it?