A Comprehensive Guide to Your
credit report & credit scoring

Credit Scores and Credit Scoring

Armed now with a clearer understanding of what makes up our credit reports and how credit reporting agencies work, we need to delve deep into the other elusive aspect of credit, and that is credit scores.

"A credit score is a numeric expression based on a level analysis of a person's credit files, to represent the creditworthiness of the person. A credit score is primarily based on a credit report."

Seems simple enough, but the procedure and process of which makes up how your credit score is calculated, is not that simple. It also is shrouded in mystery, as different lenders use different criteria or guidelines in determining what level of credit score is good enough for certain loans.

A person's credit score can be as low as 200 or even less, to as high as over 900. The lower your credit score, the more of a risk you will be viewed as to a lender. The higher your credit score, the less of a risk, and more likely to have your loan approved.

Credit Rating

And as mentioned, a bank or lender may use different scores to determine to approve a loan based on not just the score, but the lender's model.

One lender may have a policy that in order to obtain a mortgage the borrower must have a credit score of 600 or higher. Another lender's policy may stipulate that for a borrow to obtain a mortgage with them, their credit score needs to be 700 or higher.

In addition, banks and lenders may use different scoring guides based on the loan product you are applying for.

You may need a credit score of 650 in order to qualify for a mortgage, but need a credit score of 750 to qualify for a credit card.

A mortgage loan is less risky to the lender than credit cards. You may place a large deposit when applying for a mortgage, and there is the property securing the loan.

Credit cards are open lines of credit that are unsecured, and as such a higher risk to the lender.

How Your Credit Score Is Calculated

The process of how your credit score is calculated, when broken down to its various components, will make it easier to understand. The actual process used, is a bit complicated, and again, not completely transparent.

Your credit score is also fluid, meaning it can change over time. Certain factors that make up your credit score can change, and these can raise or lower your credit score.

The analogy I have used over the years and puts it into simple terms and is easy to follow, is to think of what makes up your credit score like a pie that is sliced into different sized slices.

These slices are various factors used in calculating your credit score. These factors and the percentage of weight they have towards your credit score are as follows:

Payment History

Your payment history accounts for 35% of what makes up your credit score. That is the largest percentage of all the various factors used. It is easy to see why a few missed payments or an account in arrears can damage/lower your credit score quickly.

Amounts Owed

Next up is the amount of debt you have, the amount(s) you owe on your accounts. This makes up 30%, or the next highest percentage used in calculating your credit score. Why this percentage is so high is due to the fact the more debt or high balances they have on their accounts, the more likely they are to be overextended. This is why it is not good to "max out" any lines of credit. The closer you get to your credit limit, the lower your credit score may go.

Length of Credit History

This is the amount of time you have been been credit active, or reported to a credit bureau. This makes up 15% of your credit score. The longer you been listed by a credit reporting agency, the better it is for your credit score.

Types of Credit

The types of credit you have makes up 10% of your credit score. Types of credit is the types of accounts you have. More weight is given to loans such as a mortgage, or credit card, then to a doorstep type of loan, or some other form of bad credit loan.

New Credit

New credit accounts for 10% of what makes up your credit score. New credit is when you apply for credit. If you remember from our discussion on credit reports, every time a creditor or someone views your credit history a "footprint" or inquiry is shown. Too many of these can lower your credit score, as lenders may feel you are out applying for a lot of credit and may get yourself into a financial pickle. There are some changes being made with these inquiries in that if you are applying for a car loan or a mortgage, and you apply at three (3) different lenders, as you are shopping around, these three inquires can be treated and counted as just one (1) inquiry as it can be seen you are shopping around.

Now that we are aware of how our credit score is put together and calculated, in general terms, let's look at what does affect your credit score, in positive and negative ways.

Things That Affect Your Credit Score

While there may only be five (5) major factors taking into account when calculating your credit score, there are many other smaller factors or nuances that can be used to help or hinder, the raising or lowering of your credit score.

Let's start with the five (5) basics, and then move on from there.

  • How you pay your accounts
    A no-brainer as 35% of your credit score consists of payment history. This can affect your credit score in a positive way, by making payments on-time, or in a negative way, by payments being paid late, or not at all.
  • Balances on the accounts
    The more you owe, the more affect it will have in lowering your credit score. If you have five accounts with credit limits of £2,000 and each one has £1,900, this is going to adversely affect your credit score.
  • How long have you been in the credit bureaus
    The longer you have been in the credit reporting systems, the better your credit score will be, and this ties in with paying accounts on-time. No matter how long you have been credit active, if you pay late, your credit score will be low.
  • What kinds of credit do you have
    As we discussed, having lower rated accounts, like payday loans and/or doorstep loans, will lower your credit score.
  • How often do you apply for credit
    If you apply around for a lot of credit/loans, these inquires are going to have a negative affect on your credit score.

Additional Factors That Can Affect Your Credit Score

  • Are you on the electoral roll
    Being on the electoral roll actually helps your credit. The credit reference agencies use this to confirm your address, which aids in proving where you may live, and strengthens your credit.
  • Incorrect information
    We need to review our credit reports on a regular basis to insure there is no incorrect or erroneous information on them. These errors could be lowering your credit score.
  • Court records
    Things like CCJ's will affect your credit score in a negative way, because remember, how we pay our accounts is 35% of our credit score.
  • Insolvency records
    Going bankrupt, doing a Debt Relief Order, or entering into an IVA/Individual Voluntary Arrangement are all forms of insolvency, and will negatively impact your credit score. Keep in mind, everything, including any insolvencies, drops off your credit history after six (6) years.

Things That Do Not Affect Your Credit Score

Credit History
  • Wages
    What your earnings are is not reported on your credit history and in no way affects your credit score, unless you are not earning enough to pay your accounts, and then fall into arrears.
  • Unreported loans
    If a creditor does not report a loan to the credit bureaus, it is not a part of your credit history and does not affect your credit score. This also includes any loans you may have with friends or family. These are not reported to the credit bureaus so they cannot be included in your credit history or credit score.
  • Pre-paid credit cards
    Most pre-paid credit cards do not report to the credit bureaus, so these would be treated the same as an unreported loan and have no impact on your credit score good or bad.
  • Soft inquiries
    As we have discussed, soft inquiries, such as when you review your own credit history, an employer may, or when lenders do these for marketing or pre-approved campaigns, do not affect your credit score. Only hard inquiries affect your credit score.
  • Spouse or partner's credit
    Unless you have joint accounts together, your credit history is separate from your spouse or partner's credit history. We all have our own credit reports and credit scores. It is only if you have joint accounts, could one person have an affect on someone else's credit score, and that could be for failure to make payment.

    If someone at your address does have poor credit and you think it is affecting you, you can have a Notice of Disassociation placed on your credit report.
  • Your rental history
    In most instances your rental history and your paying your rent, on time or not, will not affect your credit score due to the fact the majority of landlords do not report to the credit bureaus. So your rental payments are treated like an unreported loan. However, if your landlord reports your payment history to one of the rental bureaus, then this is incorporated into your credit report, and can affect your credit score.
  • Savings
    Any savings or investments you may have, including pensions, are not reported to the credit bureaus, so these would not impact your credit score.

How Are Credit Scores Used

Credits Scored Used

Now with a full understanding of our credit reports, and knowledge of what makes up our credit score and what does and does not affect our credit score, what are credit scores used for?

In simple terms, to make a decision or determination about something. If we remember the definition of a credit score:

"A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of the person. A credit score is primarily based on a credit report."

We can see that these scores are used to make a decision as to if a lender will grant a loan to someone applying. The higher the credit score, the more likely they are to be approved and receive the loan.

However, credit scores are used in other ways as well:

  • Loans
  • Insurance
  • Employment

Jobs

And no I am not referring to the late Steve Jobs, but there are employers that use credit history and credit scores as a part of the hiring process.

Does this mean that someone with a higher credit score will be a better employee, no it does not. There was even a study done that showed no correlation between paying your bills and how well you worked.

Naturally there are some jobs that an employer may feel a credit check is in order prior to hiring someone. If an employee is going to be handling money, or if a security clearance is required, as a part of a background check, a potential employee's credit report may be checked.

The employer doing this must get your permission to do so, and their inquiry does not impact your credit score.

Insurance

When applying for an insurance policy, be it a life insurance policy or for car insurance, the insurer may review your credit history and credit score as a part of the process of underwriting the policy.

In doing this for life insurance, it may be the person looking to be insured is asking for a huge policy which may be outside what they may be worth. A person earning £20,000 a year and asking for a £10 million insurance policy is slightly outside their financial boundaries.

In applying for car insurance, some insurers basically finance you the annual premium so you can make monthly payments. Not many of us can pay the insurance premium for the entire year up front.

The Head of Consumer Affairs at Experian, James Jones said, "Insurers will usually offer a 'pay up front' or 'pay over credit terms' option. If you do pay over credit terms, some insurers can use your credit history to determine how much extra to charge you for the convenience of spreading the cost."

Insurances

"If you pay up front then your credit history cannot be used as you are not taking a credit option. You should always be told before your credit report is accessed to calculate your credit rating and it is certainly sensible to review your credit report yourself from time to time to help make sure it paints an accurate picture of your financial situation."

The Head of Car Insurance at Confused.com, Gemma Stanbury states, "Car insurers may not view reaching the age of 70 as a poor risk factor but be more concerned with the driving experience gained and NCB (no claims bonus) earned."

"Additionally, an insurer will use a credit score to assess whether a consumer will qualify to pay by direct debit, and by doing this check it will determine the initial deposit that the consumer would need to pay towards their car insurance."

So credit scores and your credit history are used for more than just getting a loan, another reason to maintain a good credit score.

How Credit Scoring is Changing

Arrows

Just as with all businesses, you have to keep up with the times, or go by way of the Dodo.

Credit reporting and credit scoring are no different, the models and components that have been used in the past, need to keep up with the times and change as well.

In America unpaid medical bills, remember there is no NHS there, are sent to collection agencies to be collected, and can be reported as a bad debt on someone's credit history.

This was recently changed to allow the patient time to get their insurance company to pay the medical claim. If the insurer is delayed in making payment, the unpaid bill would be reported to the credit bureaus, and it could impact someone's credit score.

Fortunately, we do not have to deal with this here.

Lenders and banks want to lend money, they need to in order to make more money. However, there are a lot of people out there that have no credit, and have not been credit active; or they may have had poor credit in the past.

Since these two groups of people would have a low credit score, they may be denied a loan through traditional lenders, and may turn to payday loans or guarantor loans.

Also, just because someone may have had poor credit in the past, or they have no credit, doesn't mean they do not pay their bills on time. Bills like rent, gas, electricity, mobile phone, Internet, etc.

By using alternative factors, such as how someone pays their basic monthly bills, a new way to score someone for credit can be created.

Facebook and Getting a Loan

Social media is everywhere, and used by billions of people. We are all addicted to it and cannot imagine going anywhere without our mobile phones, and knowing where the WiFi hotspots are located.

Facebook recently received a patent which in essence allows banks and lenders the ability to grant or deny loans based on your friends on Facebook. If your friends have poor credit or low credit scores, you may be denied that loan you so badly wanted.

The patent also is supposed to aid in filtering out unwanted spam, and make search functions easier, however, it is the ability of lenders to see your friends credit rating and credit score that is the real thing we may wish to take issue with. Our credit being judged by our friend's credit.

The patent states, "When an individual applies for a loan, the lender examines the credit ratings of members of the individual's social network who are connected to the individual through authorized nodes."

"If the average credit rating of these members is at least a minimum credit score, the lender continues to process the loan application. Otherwise, the loan application is rejected."

In Washington, D.C. at the Electronic Privacy Information Center (EPIC), the Director of the Consumer Privacy Project, Julia Horwitz stated, "It's possible that this is not legal," Horwitz told the Star. "It seems that the current thinking among creditors and debt collectors is that if somebody borrows money or wishes to borrow money or needs to repay money that has been borrowed, that person's entire life gets to be exposed."

A controversial and unique way to add to credit scoring and in making a decision to grant a loan.

How To
Improve Your Credit Score

If you have checked your credit history and credit score, and feel it is not as strong or high as you would like it to be, or if you have been denied credit, there are ways to improve your credit score.

If you have had some financial disasters in the past, which has impacted your credit in a negative manner, keep in mind, "time heals all wounds", and this goes the same for credit. Everything drops off your credit history after six (6) years, but this does not mean you have to wait six years to receive credit, or improve your credit score.

A few ways to improve your credit score:

Pay your bills and accounts on time
I know I have said/written this a few times in this guide, but as payment history makes up 35% of your credit score, this is imperative to do and maintain. If you have missed payments in the past, keep on course and begin paying again in a timely manner. In time your credit score will rebound.

Keep balances on accounts low
You want to try and not have your accounts close to the maximum credit limits you may have. Remember, 30% of your credit score is made up of amount(s) owed.

Don't take out high-risk or bad debt loans
These types of loans, such as catalogues, and payday loans, are high risk and can lower your credit score.

Avoid applying for credit
The more inquiries or footprints you have on your credit report can lower your credit score. Limit applying for credit.

Get on the electoral roll By being on the electoral roll it aids lenders in knowing you are who you say you are and at what address you reside.

Correct any errors or omissions
If there are any mistakes or errors on your credit history have them corrected. You can either contact the creditor reporting the mistake directly, or go through the credit reporting agencies procedure.

Close any accounts you no longer use
By doing this you limit your access to other credit lines, which can help in making you look less in need of that access. Do NOT close out your oldest account, even if no longer used. It shows how long you have been credit active and aids in increasing your credit score.