The Break Down: Credit Scores
In line with taxes and mortgages, credit scores are among the mysterious financial realities that most students have probably heard of, but couldn't explain. In many respects, that's deliberate. Credit reference companies don't work out their scores in the same way, and the process of exactly how creditors (companies who lend money) use them is shrouded in mystery. But one aspect of credit scores that is very real is their impact on your future, so I'm here to explain what they are, and how you get a good one.
What is a credit score?
At a very base level, a credit score is a three digit number that is given to you after an appraisal of your financial credit history. To break that down into more detail, your credit history is your record with borrowing money. Therefore, money or spending you have with your debit account (money that you own that you put in a bank) doesn't count towards your credit score. If you have an arranged overdraft on a current account, (money the bank let's you spend even when your bank account is empty) then that can be included in your score. So, most simply, your credit history is the way you have spent money you don't actually have.
Your credit score takes into account a variety of different aspects of your credit history including:
Your history of repaying debts - accounts for around 30% of your score
Your credit utilisation (how much of the credit you are offered you spend) - up to 30% of your score
The length of your credit spending history
How much credit you apply for and when
The types and variety of credit you use
Who uses credit scores and what for?
Credit scores are created by credit bureaus; there are 3 in the UK called Experian, TransUnion and Equifax and the scores show others how reliable you are in borrowing money and repaying it. They are used by lenders such as banks when deciding whether to let you borrow money. People with good scores have a better chance of being accepted for loans and being offered more, whereas people with bad credit scores can be turned away when trying to borrow. Equally, those with no credit history (which is most likely you if you're reading this article) risk being rejected.
The different aspects that make up your score have different purposes:
Thinking about credit history in terms of lending money to a friend helps make sense of it; you wouldn't lend money to someone who you knew had a history of borrowing money and not paying people back (ie someone with a bad credit score.)
While creditors like to see that you have been trusted to borrow large amounts of money by other lenders, they also like to see a consistent trend of not maxing out your credit limit. If the bank offers you a £100 line of credit and you spend £50 then you have a 50% utilisation rate. Many experts recommend spending under 30% of your credit limit as a lower credit utilisation indicates you are a sensible spender.
Going back to the idea from point 1, you also probably wouldn't lend to someone you'd never met and knew nothing about (ie someone with no credit score). It's likely that you would only lend someone money if you knew they had a history of borrowing money from others and paying it back on time and in full. Therefore those with little or no history have limits on who they can borrow from.
Applying for multiple lines of credit in a short time frame shows up on credit scores and suggests you have money issues. Therefore it can hurt your score to have multiple applications in a short time and it's even worse if you're rejected for any of them.
The more variety in the credit you use, the most trustworthy you are in a bank's eyes. People with a good history repaying utility and phone bills, credits cards, arranged overdrafts, car repayments and house loans have the best chance of being approved for more credit.
How do I know my credit score?
There are a few places you can check your credit score for free online such as Experian, ClearScore, Money Supermarket, and Totally Money. Investigating your own credit score counts as a soft inquiry which, according to Experian, does not have any impact on the score itself. This is different to a hard inquiry which is when a lender you've applied to reviews your credit report as part of their decision-making process.
This can have a negative impact on your score, which is why you shouldn't apply for multiple lines of credit you don't think you'll be accepted for. If you're a student without any credit cards who doesn't pay any bills then the chances are you don't have a credit score history, though it may be worth checking if you've had previous bills or credit agreements.
How to get a good credit score
The higher your score the better, and such levels are built over time. While mortgages and other large loans may seem a long way off in the future, to secure the best position when the time comes, it's best to start your good credit now. There are a few good ways to cut off bad credit, and boost your score:
What to do
Get on the electoral register - the best way of proving your identity to creditors is putting yourself on the electoral register which you can do here even if you have no intention of voting. Any issues or concerns over your identity can be flagged on your record and prevent you being given credit.
Get a credit card or get your parents to add you to theirs - this isn't for everyone, and is dependent on individuals; being rejected for a credit card or driving up a lot of debt will actually damage your score. In next weeks article I'll explain the best ways to use a credit card to boost your score, and how to pick one, but if you know having your own isn't the right option for for you, then getting your parents to add you as an authorised user to their credit accounts can mean you benefit from their good score.
Pay your bills in full each month - this goes for all types of bills. If you have a phone or utilities bill or owe money on a card pay it off each month in full. It'll help you avoid debt and create a profile as a responsible person banks would want to lend to. If you build up consistently good payments on bills you can ask your landlord and utility companies to report your good history to the credit bureaus.
What not to do
Don't take out a pay day loan - some companies have biases against these loans and having them on your history can hurt. Additionally, with an average APR rate (that's the total cost of a loan including the interest you pay on it and any additional fees from the lender) of around 1,500%, you can end up owing more than you borrowed. These rates are often predatory and can ruin your score if you're late on payments and fall into debt you can't pay back.
Don't share a bill with a flatmate with bad credit - in credit you can often attach your score to other people's. Just splitting rent and bills won't hurt you, but if you open a joint account to pay them, then their bad score can reflect on you. One way students can risk falling into this is by privately renting with flatmates and paying bills or rent that you are “joint and severally liable” for. If your flatmate doesn't pay their share, you can be held responsible for the payment and find yourself with debts you can't pay.
Don't withdraw cash from a credit account - get it from your debit one instead. Withdrawing money from your credit account often has a similar impact to constantly applying for credit. It tells creditors you need to borrow money often and can build up over time to be a problem.
Don't go over agreed spending limits with your bank - if you have a line of credit available to you, then you should be aiming to use as little as possible of it. To do the opposite and use beyond your agreed amount can cause massive damage as it shows you can't be trusted to keep your agreement.
So what now? Don't worry too much - it's helpful to know early on what to do, but if you haven't started your credit journey yet then you're not behind anyone. Even people with terrible scores can change them over time with credit cards designed for bad scorers, and changes in spending habits. The best way to approach your credit score is keeping in mind that it will change over time, and you can improve it in small, easy ways.
Experian has an education column:
Lot's of information at MoneySavingExpert
Your bank will also have information sections online and you can call them if you want to know more about your credit with them