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The 101 Guide to Credit Scores: What You Need to Know Before Taking Out That Loan

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You have probably heard of the term “credit score” before. After all, everyone has one (even if they are not aware of it). But what, exactly is a credit score, and why does it matter?

Very simply, a credit score is a rating between one and 1,000 or 1,200 (different agencies have a different top score) that tells people who might lend you money how likely you are to pay that money back.

In Australia there are three main rating agencies: Experian, Equifax and Illion. There are slight differences from one to the other, but they all operate in much the same way: they take your history of credit repayments and borrowing behaviour, and use that to determine your score.


Why does this matter?

If you can keep a good credit score, then you gain access to two significant benefits: firstly, lenders will be more willing to lend you money, including large amounts. Home loans, for example, are much easier to secure when you’ve got a good credit rating. Secondly, you’ve got a better position to negotiate for lower interest rates; lenders know that you can go to anyone for the line of credit, so they’ll compete for your business.

At the other end of the spectrum, if you’ve got a poor credit rating, then you’ll struggle to find lenders and, if you do find one, then they’ve going to charge you higher interest rates, as you’ll be considered a higher risk customer.


What is a good credit score?

A perfect 1,000 or 1,200 is the ideal credit score, of course! But only 3.5 per cent of Australians have those, and they tend to be older people that have a long history of building up credit.

Below that there are various “tiers”:

  • 800-999 or 883-1,200: “Excellent”
  • 700-799 or 726-832: “Very good”
  • 500-699 or 622-725: “Good”
  • 300-499 or 510-621: “Average”
  • 0-299 or 0-509: “Below average”

Those that are in the “excellent” category will have no trouble securing credit and negotiating a better interest rate. Those that are “very good” or “good” will be able to find credit, though they’ll likely also need to accept the interest rates that they can find.

People in the “average” tier will probably still be able to access some lines of credit, though large loans will be difficult and the interest rate will be unfavourable. Those that are “below average” will struggle to find any lender, or the interest rates will be incredibly high.

What factors make up the credit score?

There are a wide range of factors that can impact your credit score. The main ones are:

  1. Bankruptcy or insolvency – these cause big black marks to your credit score, and remain there for at least five years.
  2. Credit defaults – if a lender has had to take action to recover an outstanding payment, it has a significant impact on your score for five years.
  3. Late payments – these can have a small impact individually, but if there is a pattern of late payments your credit score will start to drop. They remain on your record for two years.
  4. Lots of credit accounts and applications – if you are applying for credit a lot, then your ability to repay even more credit becomes a question. These remain on your record for five years.
  5. Afterpay and ZipPay – these “buy now, pay later” services allow you to make purchases and then pay them back over a couple of months, interest free. They’re a good deal for small purchases, but they can go on the credit rating, particularly if you make excess use of them. Any missed payments will also be an issue with these services, even if it’s only for a small amount.


How to improve your credit score?

The best way to improve your credit score is ensure that you are not missing payments and you’re clearing out debt without taking on any additional credit. It can be a long process, as a lot of black marks sit on your report for years, but with diligence and patience you will see that score start to climb.

But what if you have no credit history? It is still important to start building that credit score, in case you do find yourself looking for a loan down the track, but you’re not going to be able to build a history of repayments if you don’t have anything to repay!

There are a couple of things that you can do here:

1) Get a credit card with a lot maximum credit and no monthly fees

If you do not use a no monthly fee credit card, then it doesn’t cost anything to keep it, but it does improve your credit score by demonstrating credit worthiness. If you do need to use the card (emergencies happen, after all), make sure you never miss a repayment and, if you can, pay it back above the minimum monthly due.

2) Make sure you’re paying your bills

Whether it’s electricity, water, Internet or phone bills, make sure you’ve paid them on time, all the time. If you don’t, the provider may well contact a collection agency (and discontinue your service), and collection agency referrals do appear on the credit report. Conversely, though the bills won’t appear on the report if paid on time, the absence of collections will be noted when an assessor is checking your credit rating.

3) Take on a few debts

But only if you can afford to! A credit report that does demonstrate that you pay back a variety of debts (car or personal loan, credit card, microfinance, home loan), is calculated as proof that you’re financially responsible.

4) Don’t move around too much

Part of a credit score is calculated based on stability, so if you’re constantly moving houses or changing jobs, you start to look like you’re lacking stability.


In it for the long haul

Just remember: Your credit score is a lifetime rating, and has been designed as such. It takes a while to remove black marks from your name, and it takes years of commitment to start to bring the score up.

Treat it like a marathon, not a sprint, and be diligent and responsible with your money. By doing this you will reap the rewards of a high credit score when it comes time to take out that really big loan.

This content reflects the personal opinions of the author. It is accurate and true to the best of the author’s knowledge and should not be substituted for impartial fact or advice in legal, political, or personal matters.

© 2021 jacquicoombe

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