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What is a credit score and why is it important?
Learn what a credit score is, how it’s calculated, and why it matters. Discover the key factors that influence your score, and how your credit rating impacts financial opportunities.
What is a credit score?
Your credit rating is a crucial aspect of your personal finance. It’s the number which impacts your ability to borrow money and get good loan terms. It reflects your trustworthiness as a borrower, helping lenders assess the risk of lending money to you. A higher credit rating typically means you’re more reliable, leading to lower interest rates and better loan offers. This can result in substantial savings over time, especially for large purchases like a home or a car.
A good credit rating is essential for many financial decisions, including renting a new place, getting insurance, and even landing a job in some cases. Lenders, landlords and insurers often check your credit score to see how responsible you are with money. This score is a standardised way of measuring financial behaviour, making it easier for both lenders and consumers to navigate the world of credit.
How is a credit score calculated?
Your credit score is calculated using a scoring model. There are a few different models used, but each of them weighs up the following factors in order of importance, with each impacting the score differently.
Payment history
This tracks whether you have previously made payments on time, including credit card payments, rental or mortgage payments, and other regular payments, like direct debits. Late or missed payments, as well as defaults and bankruptcies, will negatively affect your score.
Credit utilisation
This measures the amount of credit you use, compared to the total amount available to you. A low ratio indicates that you are good at managing your finances, and don’t rely heavily on credit.
Length of credit history
This measures the amount of time you have had active credit accounts. A longer history can work in your favour, as it can suggest that you have more experience of finance management.
Types of credit
A mixture of credit types can positively impact your score, including credit cards, rental or mortgage payments, direct debits and instalment loans.
New credit
This counts how many recent credit enquiries you have made, to check for risk - if an individual has opened a number of accounts, or set up several new payments, in a short amount of time, that can negatively affect their score.
Maintaining a good credit rating means managing each factor effectively, to create good creditworthiness, and a higher score.
Why is a credit score important?
Having a good credit score and a solid credit history can open up more financial opportunities, such as securing a rewards credit card or having access to higher credit limits. On the other hand, a low credit rating can limit your borrowing options, lead to higher interest rates, and can even lead to loan applications being denied.
To keep your credit score in good shape, you’ll want to make sure you pay bills on time, manage your debt levels wisely, and regularly review your credit report for accuracy.
Different credit score ranges and what they mean
Credit scores vary slightly for different scoring models, the following ranges are generally used.
Poor
Individuals in this category are generally seen as high-risk borrowers. This might mean that they have a history of late or missed payments, high levels of debt, or little to no credit history. Lenders might deny a credit application, or attach high interest rates, to offset their lending risk.
Fair
This category suggests a moderate amount of risk. If you fall into this grouping, lenders may want to offset their lending risk, so you might attract higher interest rates or less favourable borrowing terms.
Good
If you have a good credit rating, you’re demonstrating a solid credit history, meaning that you will pose less risk for lenders. Individuals in this group will usually receive better terms and lower interest rates, having demonstrated responsible finance management.
Excellent
This is the highest scoring group. Individuals in this range typically have a long history of timely payments, a low ratio of credit utilisation, a good mixture of credit in a well-managed financial portfolio, and pose very little risk to lenders.
How to check your credit score
Checking your credit score is easy, and doesn’t impact it at all! There are three main credit reference agencies in the UK that you can use: Experian, Equifax, and TransUnion. Each uses a different scale and methodology to calculate your credit score, so it may vary between the three, but they’ll all give you access to your credit report. Under UK law, you can request a copy of your credit report once a year from each of the three agencies (they can charge up to £2 each time, but most won’t charge anything).
You can also use comparison websites, such as ClearScore or Credit Karma, or even see if your bank offers a credit report service.
When you check your score in these ways, it’s called a “soft enquiry” and does not affect your score. But bear in mind that applying for credit leads to a “hard enquiry” which can temporarily lower your score.
Steps to build and improve your credit score
Improving your credit score, especially as a young adult or as someone new to credit, has long-term benefits for your financial future. There are many ways to boost your credit rating, but some effective strategies include:
Make timely payments
Your payment history is the most significant factor in deciding your credit score. Ensure that you make payments on time, and never miss a due date.
Keep your balance low
Try to keep your credit utilisation ratio to under 30%. In practice, this means that if your credit limit is set at £1000, you should aim to not use more than £300.
Avoid excessive credit enquiries
A “hard” enquiry will lower your score, though most lenders will do a quotation “soft” search for you which won’t impact your credit profile. You’ll also want to avoid making multiple applications at once, as this can be seen as risky financial behaviour.
Build a credit history
If you’re new to credit, or don’t have much credit history built up yet, start with something small and make your payments on time and in full to help establish a good credit history.
Maintaining good financial habits will positively impact your credit score rating, which will build over time. Financial education is the best way to make better financial decisions, leading to more opportunities in the future. You’re already here reading, which is a great first step!
FAQs about credit scores
If my credit score is low, can I still borrow?
If you have a poor credit rating, some lenders will deny an application, while others may offer less favourable terms. If you start small, you can build up a better credit score and improve your rating (and therefore your borrowing power) over time. We’ve looked at what makes a “good” credit score rating, here.
What information will credit agencies have about me?
Credit agencies will have access to your personal and financial data, in order to help financial institutions assess your risk level. This information includes your name, recent addresses, DOB and NI Number, as well as your payment histories, details of credit and store cards, account status, and public record information such as CCJs or bankruptcies.
How can I build up my credit score?
Maintaining good financial habits is the best way to boost your credit score. Scroll up to read our strategies for improving your rating.
Does checking my own credit score lower it?
How long does it take to improve a credit score?
Why are there different credit scores?
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Representative Example | |
---|---|
Loan amount | £10,000 |
Interest rate | 13.9% APR |
54 payments of | £246 |
Total cost of credit | £3,284 |
Option to purchase fee | £1 |
Total payable | £13,285 |
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