Your credit score is a magic little number that can have a surprisingly big impact on your life. Your credit score is a three digit number used by lenders to determine how likely you are to repay them on time if they accept you for a loan or credit card. A poor credit score limits the availability of credit cards and loans leaving only the most expensive options (the ones with the highest interest rates) open to you. The higher your score is the higher your chances of qualifying for credit cards or loans with more favourable terms so it is important to maintain a good credit score or improve it if you currently have a poor score.
How Scores Are Calculated
Credit scores can be over complicated and the finer details can be a little tricky to understand, thankfully the specifics are not important so long as you have a basic understanding of the fundamentals. Your credit score is determined by applying an algorithm to one of your credit reports (there are three of them). There is no one algorithm used by all lenders (although there are more commonly used ones such as the fico score) but the factors that are rewarded or penalised are the same so the principles in this post will help you regardless of the score lenders look at before deciding whether to accept you.
Factors scores generally look at include your history of repaying loans and credit cards, how long you have had accounts open, and the amount of accounts you have and how often you apply for new credit.
The point of a credit score is to indicate the likelihood you will repay lenders in full and on time, as such it is unsurprising that how you have paid bills in the past is a key factor in determining your credit score. Paying your bills in full and on time will affect your score positively whilst a history of missing payment dates or not paying in full will damage your score. It is important that you pay all your bills from utilities and rent to loans and credit card bills as they can all affect your credit score.
Your more recent history has a bigger impact on your score than older data so the sooner you can bring your payments up to date the better this will help in improving your score.
Credit cards and how you use them can have a big impact on your credit score but by following the tips outlined below you can make it a positive impact that works in your favour by improving your score.
Firstly pay attention to your credit utilization ratio, which despite its fancy name is simply how much credit you use compared with how much you have available with revolving credit. For instance if your total credit limit for all your credit cards was £5000 but if you only charge £1000 a month (on average) your credit utilization ratio would be 20%. Pay off debt and keeping your credit card balance low will help you achieve a low credit utilisation ratio. Lenders typically look for a ratio of 30% or less as it indicates you manage credit well but don’t go opening accounts just to lower your ratio just yet.
Opening credit card accounts incurs a hard inquiry on your credit report. A hard inquiry can have a slight detrimental effect on your credit score and comes when you apply for credit such as a loan or credit card. So whilst running out and opening accounts may seem a great way to reduce your credit utilization ratio overall it is generally not worth it. Only open accounts when they are needed.
On the other side of the coin do not rush to close account you do not use. You will already have had the hard enquiry so unless they are costing you fees keeping it open may be a good option, keeping your credit utilization ratio lower.
Shy of huge financial mishaps your credit score is not a fickle thing that will crash or grow exponentially overnight. However continual “bad behaviours” that damage your score add up over time and similarly behaviours and practices that improve it also increase your score over time. The key to building your credit score is consistently doing the right things there are no overnight fixes but by paying attention to the points outlined in this post you can work towards building your score and increasing your options when trying to acquire finance.
If you want to check your credit score you can compare score checking tools here.