Your credit score and why it’s important
What is your credit score? How can it impact your ability to take out a home loan, buy a house, serving a home loan?
Your credit rating or ‘credit score’ is a numerical score that represents how trustworthy your reputation is as a borrower.
That means it’s a pretty important part of the process when applying for a loan according to Mark Polatkesen, Director and Senior Mortgage Broker at Mortgage Domayne. “Your credit score says a lot about your financial history,” he says. “Generally, this includes amounts you’ve borrowed in the past, how many loan enquiries and applications you’ve made previously, and your record of repaying these loans.”
He adds, “That makes knowing your credit score is a vital part of understanding your credit health because it will directly influence the amount of credit that a lender will make available to you as a borrower (your credit limit) and, depending on your score, it could also impact the term and interest rate they will offer. “
How is your credit score calculated?
In Australia, there are three main national credit reporting agencies – Equifax, Experian and Illion, that collect a wide array of information which they use to determine your credit score.
As there’s no universal system, each agency uses their own methods to calculate your credit score, analyse your credit history, credit profile and past credit applications, so they can obtain a better understanding of your behaviour as a borrower. That means there will also be differences in their scoring systems. For example, Experian and Illion have a score range of 0 to 1,000, while Equifax Australia has a score range of 0 to 1,200, with the result that your credit profile may differ between credit score providers. Each of the three agencies listed here allow you to order a free credit report once every 12 months, making it easier to get a better idea of your credit history across all of them.
Historically, credit reporting focused primarily on negative credit events. But the introduction of Comprehensive Credit Reporting (CCR) in Australia has meant that both negative and positive information can be included on your credit report. This ensures that any positive actions you make, like making monthly payments on time, are also noted. Additionally, CCR now requires lenders to share more data. Previously, only information about credit enquiries, credit provider names and overdue credit account details was recorded in consumer credit files. Now, additional information such as the type and amount of credit applied for, credit limits for each account and repayment history are also included.
The result is a more accurate and comprehensive picture of your credit history than ever before – which may well assist those with a thin or short credit history and reduce the impact of a single negative event. For example, with more information available to credit reporting agencies, Mark says you may well see an improvement in your credit score if you’ve been good with your repayments. But he cautions that credit scores are only as reliable as the information that has been provided to credit reporting agencies and your lender. “The more information credit reporting agencies have at their disposal, the more accurate your score is going to be.”
What credit score should you aim for?
The higher your score the better, because it will affect your access to better loan and credit card deals. The following credit score bands are from Equifax and are as follows:
- Excellent: 841 – 1,200
- Very Good: 756 – 840
- Good: 666 – 755
- Average: 506 – 665
- Below Average: 0 – 505
So, what factors do credit reporting agencies look at in determining your credit score?
Credit reporting agencies will take a number of factors into account when calculating your credit score.
Your Credit History.
Your credit history is assessed based on factors including:
- The presence of high-risk indicators like defaults, bankruptcies, court judgements and credit infringements can all negatively impact your credit score and can stay on your credit file for 5 – 7 years.
- The type of credit providers you’ve submitted applications to in the past. For example, the degree of risk can vary depending on the type of credit provider you may have used previously, with payday loan applications viewed in a different light to loans from a bank.
- Repayment history of your credit accounts. Consistent on-time repayments can contribute positively to your credit score.
Your Credit profile.
Factors impacting your credit profile include:
- The age of your credit history. Holding a shorter credit history often represents a different level of risk to one that is much longer.
- Your personal details including your age, duration of employment and how long you’ve lived at your current address.
Previous Credit applications.
Consideration will also be given to your previous credit applications including the following:
- The amount and type of credit you’ve applied for in the past. Every time you apply for credit an enquiry is recorded which remains on your credit report for five years. According to Mark, “If there are too many enquiries recorded over a short period of time, it could raise a red flag to your potential lender that your finances are in poor shape.”
- Having fewer and more infrequent credit enquiries is typically preferred.
So, what can you do to improve your credit score and improve your chances of obtaining a home loan?
The list of things that can affect your credit report, for better or worse, is pretty lengthy, but if you’re looking for some pointers to help push your credit score in the right direction, here are Mark’s top tips to get you started.
Get on top of your bills and debts.
Mark’s number one tip? “It’s really just common sense, but the best thing you can do if you ever plan to apply for a loan, is to pay your electricity, water, phone, credit card and other bills on time. While some creditors might provide a little leeway every now and again and/or only impose negligible late fees – don’t rely on these. Paying your bills on time each month can help to boost your credit score, allowing credit reporting agencies and lenders to look to your past behaviour as an indicator of how you’ll act in the future. Doing things such as setting up direct debits, building a budget and letting your creditors know ahead of time if you think you’ll be unable to pay, will all also help you keep on top of your payments.”
Lower your credit card limit.
Tip number two? “If it’s possible, lower the limit on your credit card,” says Mark. “Not only will it help with the excessive spending, but again it can assist in improving your credit score.”
He also recommends considering credit cards with no annual fees, lower rates of interest or ones that offer initial no interest periods, but cautions against applying for too many credit cards or loans.
Keep your credit enquiries to a minimum.
According to Mark, your credit score doesn’t just come down to how much you’ve borrowed, or even how many loans you’ve taken out or are paying back; it also reflects how many enquiries and applications you’ve made previously.
“Every time you apply for credit, a credit enquiry is left on your credit report,” he notes. “So, having too many credit enquiries in a short period of time can act as a red flag and reflect poorly on your credit score as it can appear to potential lenders that you’re desperate for credit or struggling to get approved, even if you’re in good financial standing.” To avoid this issue, he recommends always taking a step back and considering whether you actually need the loan or credit card right now, always doing your research and only proceeding with an application when you’re sure you are ready to apply.
However, what won’t have a negative impact on your credit score is checking it. Says Mark, “It’s a persistent – but completely incorrect – myth that asking to see your credit report will negatively affect your credit rating somehow. So, don’t let this be a barrier to finding out our credit rating so you can then take the necessary steps to improve it”.
Check your credit report for any inaccuracies.
Taking some time to check your credit report properly can help you find details that might be negatively impacting your credit score. Well ahead of applying for a loan, Mark recommends that customers take a look at their reports from the three major credit reporting agencies to see if anything stands out. “If you do find anything that doesn’t seem quite right, clarify it with your creditors or find out more from the relevant credit reporting agency.”
This may sound counter-intuitive, but according to Mark sometimes doing nothing can actually help your credit score. “Each day that passes without you jeopardising your file gets you a step closer to the expiry dates on credit inquiries and black marks that may be negatively impacting your score.”
While it doesn’t necessarily guarantee your application will be approved, having a positive credit history can put you in good stead when submitting your next personal loan, home loan or credit card application, noting that while it’s an important factor in the approval process, it’s not the only one considered, with lenders taking other factors, such as your ability to service a loan or credit card, into account.