Most of us will need a little financial help, especially when it comes to buying something major. A car, a holiday, renovations, or even to consolidate high-interest debts like credit cards. For those of us wondering how successful our loan applications will be or what interest rate we’ll be entitled to, our credit rating, also known as a credit score, can influence a lender or bank’s decision. So how does a credit rating influence a personal loan application? How do credit scores work?
Credit reporting makes the financial world work
Individual credit reporting is the first “port of call” when a bank, lender, or company that extends some sort of credit (like telcos for example) wants to assess your creditworthiness. This means your ability to pay back lenders based on your track record.
A company called a credit reporting agency collects this data through sources such as financial transactions, credit applications, the number of checks on your credit, reporting by banks and lenders if you are not paying your debts on time, or by utility companies if you don’t pay your bills. These are known as defaults. Credit scores help businesses figure out their risk; the higher the risk, the less likely they want to deal with that risk.
Your credit score explained
Your credit score usually ranges from 0 to 1,200 – though some agencies (in Australia especially) rate customers from 0 to 800. Ratings between 833 and 1,200 are considered “excellent,” and a rating between 832 and 622 is considered “good” while credit scores below 621 are considered “poor.” A poor score means higher risk, which makes banks and lenders reluctant to lend to such customers. Lower credit scores mean more expensive personal loans
As “insurance” against a customer defaulting on their loan, a lender will charge higher interest rates (known as “sub-prime” or “bad credit”) to compensate for their risk. Someone with “excellent” credit may gain a loan at 9% - people with “poor” credit could face interest rates upward of 20%.
How to improve your credit score
Fortunately, credit reporting agencies keep only seven years’ worth of records. You can start correcting your credit over time by paying all your bills on time and in full and paying off debts. Another good idea is to lower your credit card limits – if you have a $10,000 limit you never use, lower it to something within your means. You should also limit the amount of credit applications you make, as this can contribute to lowering your score.
Credit reports can also contain errors – and it’s up to you to fix them. If you lived in a sharehouse and one tenant forgot to pay a bill in your name, the default will be applied to you. Make sure to get your free credit report from a credit reporting agency before applying for any kind of loan. It might save you money.