All of us have a credit score, though many of us don’t understand them.
According to Wealth Advisor, just nearly half (49%) of people in Britain have never checked their credit score. Moreover, almost a third (32%) don’t know how to check. Nor do they know what makes their score increase or decrease, or why this number is important.
But our credit scores are a vital measure of our financial health. It impacts so many parts of our lives – our access to current accounts and credit lines (like overdrafts and credit cards), our phone contracts and utility services, our ability to get a mortgage or rent a flat. Some employers might even ask to run a check depending on the role, especially at major financial companies or consultancies.
The point is your credit score is important – even if you’ve never had to think about it before.
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What are credit scores?
Investopedia defines a credit score as ’a number given to each of us to indicate our creditworthiness’. Our score represents the likelihood of us repaying what we’ve borrowed, or how financially trustworthy we are.
In general, the higher the credit score, the better we look to lenders and other financial providers – this is because it tells them that we’re good at meeting our commitments (ie. paying back our overdraft, credit card, or another loan) on time. On the other hand, if you regularly miss loan repayments then your score is likely to be lower.
How do credit scores work?
“Credit scores are used as an indicator of behaviour,” explains Edgar de Picciotto, co-founder of ikigai. “Helping lenders decide things like how much credit you can have access to or what interest rate you should have on your borrowing. If you have a high credit score, you may be able to borrow more on things like your Amex or have an extended overdraft, for example, whereas if your score is lower, you may find it harder to do things like take out a mobile contract or get a low-interest mortgage.”
But because a credit score is predominantly used by lenders (rather than by us) to decide whether we qualify for certain financial products, the world of credit scores isn’t all that simple.
Almost every lender has their own system in place to decide whether to accept you as a customer – so whilst one bank might reject you for a new account or card, another might accept you for an almost identical product.
Your credit score can, however, give you a pretty good understanding of whether you’re more or less likely to be accepted for one card or loan over another.
As Edgar explains, “If your score is higher, you’re seen as a more trusted borrower, so you’re more likely to be given better deals on credit. The important thing of course with any loan or credit line is to make sure you’re able to make the repayments, do so on time, and that it meets your financial needs.”
How is your credit score calculated?
Your credit score is calculated based on your credit history – which is basically just a track record of how you’ve handled debt in the past.
If your history shows that you’ve handled credit well (ie. paying on time, not missing payments, using reputable lenders, not taking out a lot of different loans all at once etc) then it’s likely your score will be pretty decent. If you’re a regular misser of repayments, have defaulted or taken out lots of credit cards in a short space of time then your score could have taken a hit.
The thing is every time you apply for credit or open a bank account with lending features (like an overdraft), it leaves a footprint on your credit history. These are called ‘credit checks’ and you may sometimes hear people discussing ‘soft’ and ‘hard’ credit checks when you’re applying for a loan or opening an account. So-called ‘soft’ checks may leave a mark on your account but don’t generally impact your score – they include things like background checks or typical ‘KYC’ checks – and will typically disappear after 24 months.
On the other hand, ‘hard’ checks take place when you’re applying for credit and may leave a more significant marker on your history and may not go away for a much longer amount of time.
What affects my credit score?
The main factors that impact a credit score negatively are a significant number of credit enquiries in a short space of time (ie. trying to take out multiple cards or open several bank accounts at once), defaulting on payments, payday loans and outstanding accounts with debt collection agencies.
Court records (like bankruptcies and court debt) are also reviewed, as well as data around your financial behaviour (like whether you pay back in full, in part, the minimum, or defaults on a loan).
Of course, it’s not just banking and loans. Your history also considers things like your phone contract, your age, any past court records and where you live. It may seem a little nerve-wracking, but it’s key to stay on top of the information used by credit reference agencies and lenders. For example, if you move out but don’t update your info, you may be accidently associated with the new tenant – which can be an issue if they have a poor credit score.
But it goes both ways – you can improve your credit score too. Having a stable address, making repayments on time, and being registered to vote can all help bolster your credit score in the right direction.
How can I find out my credit score?
These days there are quite a few credit reference agencies that calculate your score – Experian, TransUnion and Equifax are ‘the big three’ (yeah, who knew there were so many), but younger fintechs like ClearScore and Credit Karma also offer the ability to see, track and better understand your credit score too. A lot of these offer a free credit score check, with options to upgrade to get more detail.
The great thing about many of the credit reference agencies is that if you have a lower score than you’d like, they now offer tools that can help you improve it over time.
For example, I know a lot of people who have found Experian’s ‘Boost’ super useful. This is a feature that can help you increase your total credit score by sharing how you manage your money. It includes things not usually included on a credit history such as payments into a savings account, Council Tax, subscriptions to digital services like Spotify and Netflix etc. If you’re looking after your money and meeting regular payment commitments, they can help you improve your score.
The downside? You might find yourself being followed around the internet by ads for credit cards, banks and assorted financial services. It can be a little eye-roll-inducing, but it’s not going to impact your score.
What’s the average credit score ?
Most credit score agencies have five categories for credit scores: excellent, good, fair, poor, and very poor. However, not all credit agencies use the same scale – so whilst Experian gives a score from 0 – 999, TransUnion’s range is 0 – 710. Equifax’s score used to run from 0 – 700, but it has this week updated to range from 0 – 1000 to help their customers better understand their credit information.
The average credit score in the UK is ‘fair’ across all the different reference agencies (ie. between 710 – 880 with Experian; 566 – 603 with TransUnion etc). This means whilst you might get decent interest rates, your credit limit is likely not that high.
If your credit score is ‘Good’, you should get most credit cards, loans and mortgages (although perhaps not the very best deals, which are more likely to be accessible to you if your score is ‘Excellent’). On the other hand, if your score is ‘Poor’ or ‘Very Poor’, you may find it very difficult to get access to credit or a low-interest deal.
Certain cities, demographics and age groups also do slightly better than others when it comes to access to affordable credit.
Only two per cent of people aged thirty or under have ‘excellent’ credit scores, with people aged 26-30 having the lowest scores on average. However, from age 31, your score does tend to go up, peaking around age 55.
A significant challenge is the gender and ethnicity credit gap as the processes used to determine credit worthiness can unwittingly perpetuate unfairness in the credit system. As a study by research firm BDRC Continental for UK Finance (then the British Bankers Association) pointed out, 73% of black-owned businesses had a higher-than-average risk rating, compared to 47% of UK SMEs overall. Likewise, Credit Karma’s data shows that women are paying up to £17,000 more than men to borrow money over their lifetime.
The fact is that certain genders and ethnic groups have lower credit scores than the ‘average’, putting more people from these groups into sub-prime lending categories.
How do I improve my credit score?
Improving your credit score isn’t exactly simple and it can take quite a bit of time to build it up. But it’s not impossible – even if you have some historic missed payments or defaults.
Five of the most common recommendations for fixing your credit score include:
- Build up a credit history – Contrary to what you might expect, if you’ve never had a credit card or overdraft, this might be working against you. Lenders rely on your history to calculate your score, so if you don’t have a history for them to analyse, they can’t tell what kind of borrower you are. If you do take out a new card or loan, however, remember to always pay the balance off in full and on time.
- Register to vote – Yup, who knew there were additional benefits to being on the electoral roll? This is seen as a sign of stability by lenders, making it an easy way to confirm your identity and primary residence.
- Punctuality, punctuality, punctuality – Paying back on time shows lenders that you’re a responsible borrower, so things like setting up reminders or direct debits can help you stay in control and on time.
- Pay off outstanding debt – Given how high interest rates are right now, it may be better to pay off expensive debt rather than build up your savings. This may also give your score a boost by clearing some of your outstanding borrowing.
- Check your credit report regularly – If you’re considering taking out a new loan or credit card, checking your report can help you work out the products that are best for you and that you’re most likely to be approved for, as well as the best timing.
For example: If you’re going through a breakup, decoupling your finances is a key one so that your partner’s money habits don’t impact you. If you’re moving house, make sure to update your address across all your financial products as soon as possible. If you’re on holiday, don’t take cash out using a credit card. If you’ve got cards still that you’re not using, cancel them.
The point is there are lots of ways to support your credit score and help build up a better one if you need to. Many of the agencies can help you better understand exactly why your credit score is good or bad, and how long it’ll take to improve your score.
And there’s loads of great advice out there too.
But the most important thing is to first know what you’re working with.
Find out about your credit score, take the time to understand why it is what it is, and you’ll be able to make changes so that your score is as high as it can be and you can live a healthy financial life.
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We built ikigai specifically for those who want to bring their lifestyle to the next level, by taking better care of their finances.
ikigai beautifully combines wealth management and everyday banking in one single app. And by doing so, it creates a whole new world of opportunities.
Visit https://ikigai.money to find out more.Maurizio & Edgar, Co-Founders, ikigai
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