Credit Scoring - How does it work?
So how does credit scoring actually work? Most people don't know it but you do not have an accurate credit score. This is because each lender scores you differently based on your spending history and the lenders idea of a 'perfect customer'. When you apply for a mortgage, credit card, loan, mobile phone or any form of credit the lender will 'score' you based on a number of parameters, one being your spending behaviour. These 'scores' are never shared with other lenders as each lender has their own criteria so if you get rejected by one doesn't mean you will automatically get rejected from all others.
Do blacklists exist?
In a nutshell, No. Although each lender will give you their own version of your 'credit score', the information they use is similar. They will use other information abut you to determine whether they want to dish out credit to you. Here are some examples;
- How long have you lived at your current address?
- How long have you been with your bank?
- Have you been making the minimum payments towards your debts?
- Have you missed any payments?
- Have you been paying your balances off in full?
So if I always pay my balances off in full, does it mean I have a good credit rating?
No not necessarily. One thing to keep in mind with credit scoring is it's about 'PROFIT' not 'RISK'. For instance, if a lender sees you pay your credit card balances off in full every month the bank will not make any money, therefore you are more likely to receive a lower credit score from this lender. From the banks perspective, it's all about making money so if you are paying off your balances in full they will be no interest for them. Strange, but true! Of course, risk does play some part in the decision making process as people who do not repay their debts are not ideal candidates to a lender as the lender will not make any money.
Example: (This is a true story taken from a recent survey)
'John Smith' has just moved into a new house and has been there for 3 months. He has 4 credit cards all with about 75% credit used on each, totaling around £13,000. He has 2 loans, 1 for £8,000 and 1 for £10,000, so his total debt equates to around £31,000. He has been with his bank for 11 years. He has been in full time employment for a year. He always pays just over the minimum payment each month to his credit cards. John recently got accepted for an additional unsecured loan of £20,000 from his own bank.
Now, you may find this surprising as you would think a candidate like this may struggle to get further credit, but john 'NEVER' pays the absolute minimums and 'HAS NOT' missed a payment in the last 6 months. This is a very important factor for lenders as even though he is paying close to the minimums it shows that he is reliable and he is committed to paying the debt off.
So paying off your balances in full every month, constantly moving your balances to 0% interest or not using your cards enough may result in you struggling to gain further credit. Lenders make the most money from people who are constantly in debt and just meeting their minimum repayments each month.
So if I have a bad credit rating, how do I improve it?
There are a number of ways you can improve your credit rating.