Understanding Your Credit Score

When you apply for credit, lenders will look at various aspects of your credit history to help them make a decision - one of which is your 'credit score'. But what exactly is your credit score? And, why is it so important? Put simply, your credit score is a three-digit number that demonstrates how likely you are to repay any money you borrow.

However, because your credit score is an indication of how well you've handled credit in the past, any financial decisions you make can have a drastic impact on your credit score - for better or for worse. By understanding your credit score and the various factors that can affect it, you can improve your creditworthiness and have greater control over your finances.

How does my credit score work?

The higher your credit score is, the more creditworthy you are, and the more likely you are to be approved for credit.

There are three credit reference agencies in the UK (Experian, Equifax, and TransUnion), each of which collects financial information on you from different public records and service providers. This information is then transformed into a three-digit 'credit score' or 'credit rating' which is essentially an indication of how likely you are to repay money you borrow based on your past credit history.

The higher your credit score is, the more creditworthy you are, and the more likely you are to be approved for credit. However, it's worth noting that although your credit rating plays an important role, it's not the only aspect of your credit history that is considered when you apply for credit and a good credit score doesn't necessarily guarantee approval.

Because each credit reference agency places emphasis on different aspects of your credit history when calculating your credit score, your credit rating can also differ slightly depending on which credit reference agency you use. 

What is my credit report?

The terms 'credit score' and 'credit report' are often used in conjunction with one another, but while they are related, they are not the same.

Put simply, your credit report, or credit file, is the document that holds all the financial information that makes up your credit score. This includes existing credit agreements, repayments, and defaults - most of which remain visible for several years before being removed.

For example, if you default on a credit agreement, a 'default' marker will be added to your credit report for six years. During this time, your credit score will be negatively impacted and you'll find it difficult to access further credit, such as a personal loan, mortgage, bank account, or phone contract.

The financial information included on your credit file is used by credit reference agencies to determine what your credit score should be and any financial decisions you make can increase or decrease your credit rating.

Which factors affect my credit score?

Generally, making too many applications for credit in a short space of time will negatively affect your credit score.

There are various factors that can affect your credit score and some credit reference agencies place more importance on some than others. Here is a quick guide to the main factors that can increase or decrease your credit score:

Your credit and payment history

The biggest factor that can affect your credit rating is your credit and payment history. For example, if you have a history of missed payments or defaults, your credit score will be lowered to reflect this and lenders may be less willing to enter into a credit agreement with you.

Even if you have a good income and no history of debt, your credit rating may still be low because there's a lack of information available for credit reference agencies to base your credit score on.

Your available credit

The amount of available credit you're not using on your lines of credit or credit cards can play a crucial role in determining your credit score - this is commonly referred to as your 'credit utilisation ratio' or 'credit utilisation rate' and is usually expressed as a percentage.

For example, if your credit card has a limit of £1,500 and you use around £750 a month, your credit utilisation ratio is 50%. The ideal credit utilisation ratio can differ but anything under 30% is generally viewed as favourable by most lenders which, in this case, would be around £450 a month.

Your credit mix

The range of credit you carry, or your 'credit mix', can also impact your credit score. By having a combination of credit accounts (e.g. mortgages, loans, and credit cards) on your credit file, you can prove to lenders that you're capable of managing several different types of credit.

This can not only improve your credit score but also encourage lenders to let you access further credit as they'll have no reason to worry about you meeting the terms of your credit agreement.

Your credit applications

Generally, making too many applications for credit in a short space of time will negatively affect your credit score. This is because, every time you make an application for credit, a 'hard search' will be carried out and recorded on your credit report for 12 months.

This can make lenders wary of entering into a creditor agreement with you as it indicates that your financial situation is poor and you may not have the available funds to repay the money borrowed.

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How do I check my credit rating?

The easiest way to check your credit rating is to request a free credit score check from any of the main credit reference agencies.

Remember, although each credit reference agency uses a different scoring model, your credit rating is based on similar criteria so there is no need to access your credit report from each of the main credit reference agencies separately.

Most credit reference agencies provide a free statutory credit report, but you may need to create an account first. There may also be an option to request a paper copy of your credit report, but this usually requires you to mail an application form to the credit reference agency.

What is a good credit score?

Because credit references use different scoring models and numerical ranges, what is considered a 'good' credit score can vary slightly depending on which credit reference agency you use.

However, most credit reference agencies calculate credit scores on a sliding scale so your credit score is likely to fit into the same category regardless of which credit reference agency you use. This means that there's no magic number you should be aiming for and as long as you're making positive financial decisions, your credit ratings should reflect this.

Experian, for example, provides a credit score of between 0-999 and defines anything between 881 and 960 as 'good', Equifax provides a credit score of 0-1,000 and class anything between 531 and 670 as 'good', and TransUnion provides a credit score of 0-710 and considers anything between 604-627 as 'good'.

How can I improve my credit score?

There are several things you can do to improve your credit score and get your finances back on track. Whether you've recently exited a formal debt solution or want to buy a home, here are some of the actions you can take to achieve a better credit score:

Check for errors and mistakes

Most people assume that the information contained on their credit report is accurate and up to date, but errors and mistakes can happen and your credit rating could be lower than it should be due to a simple misunderstanding.

The best way to protect your credit score is to view your credit reports on a regular basis and keep an eye out for anything that doesn't look right. Something as simple as an old address or misspelt surname could be unfairly damaging your credit score and preventing you from accessing the best deals.

Make payments in full and on time

The easiest thing you can do to improve your credit score is to make timely payments when it comes to your household bills, mortgage payments, and court judgments.

This can prove to lenders that you're a responsible borrower and are capable of handling different forms of credit responsibly. Some lenders also view old, well-managed credit agreements as a sign that you have experience making payments in full and on time and are a reliable borrower.

Register on the electoral register

The information contained on the electoral register, or electoral roll, is accessed by lenders when they need to update your credit file. This helps them confirm your identity and, more importantly, rule out the chances of you making a fraudulent claim.

Generally, the easier it is for lenders to confirm your identity, the less of a risk you will pose, and the more your credit score will improve. This will make it easier to get approved for credit and you'll likely face fewer rejections.

Use a range of credit options

The more credit options you have listed on your credit report, the more you can prove to lenders that you can manage different types of credit. This is sometimes referred to as your 'credit mix' or 'credit diversity' and could include a combination of personal loans, credit cards, and payday loans.

Most lenders recommend having a combination of instalment loans (loans repaid over time with added interest) and revolving debt (open-ended credit agreements) for maximum diversity.

Conclusion

The importance of your credit score can't be understated - it's essentially a record of all the financial decisions you've made in the last six years and can be the difference between you being accepted or rejected for a loan.

By understanding your credit score and how it works, you can make better financial decisions and improve your chances of being approved for credit, whether you're planning to take out a personal loan or apply for a mortgage.

There are several things you can do to improve your credit score, from making payments in full and on time to registering on the electoral register. This proves to lenders that you're a reliable borrower and can be trusted to stick to the terms of a credit agreement.