What Is a Credit Score, and How Can I Improve It?
There’s this number following us around. Everyone’s got one.
It’s called a credit score.
Many people don’t think about their credit score until they need it, like when they want to get a mortgage. But it’s good practice to get familiar with credit scores and the crucial role they play in your financial life.
What is a credit score?
In Australia, a credit score is a number between 0 and 1200. Although other countries have credit scores as well, the range can be different. In the US, credit scores are 0 to 800.
By legislation, you’re allowed to get your credit score once every year for free. Checking your score annually is an excellent habit to get into. Have a look; see what it is. You can even see what lenders have put on your file.
What does your score mean?
If you have a credit score between 0 and 509, your score is below average. That means that it’s more likely that an adverse credit event will happen over the next 12 months.
An average credit score is 510 to 621 and places you in the 21% to 40% range of the population. This score indicates that it is likely you may have an adverse event in the next 12 months.
A good credit score means that adverse events are less likely. That score is 622 to 725, about 41% to 60% of Australians are in the “good credit score” range.
Very good is 727 to 832, which indicates that unfavourable events are unlikely. Then there’s the excellent score, which is where we all want to be, which is 833 to 1200. That means it’s highly unlikely for an adverse event to occur.
So, that’s the full range of credit scores in Australia. And again, it’s best to be at the higher end of the spectrum than the lower.
What impacts your credit score?
When you look at your credit score and what’s on your credit report, it’s essential to know what’s driving that number.
The most significant component driving your credit score is your payment history – do you pay your bills on time? If you do, you’re going to have a higher score. If you don’t, you’ll have a lower score.
And if you don’t pay them on time, how late are you? How late your payments are, is also a contributor. Have you had one payment a little bit late, or do you have a bill (or more than one) that’s 30 days late, 60 days, 90 days, or even more?
The later and more frequently you have late payments in your payment history, the more impact it will have.
Although it could be worse, maybe you’ve had a bill you never paid, or you’ve had collections against you.
If you’ve had collections, that’s a huge red flag against your credit score.
Do you have any debt settlements, bankruptcies or foreclosures in your name? These all indicate your payment history and your ability to pay future lenders back.
That payment history is about 35% of your score.
How much you owe
About 30% of the score will come from how much you owe and how much credit you use; this element of your score is relatively easy to manipulate.
We often think that we get higher credit extensions from our bank because they believe we are great. But they really want you to borrow up to your limit. The more you borrow, the more they earn in interest.
But that doesn’t mean a high credit limit will look good on your credit score.
Somebody who owes $10 towards a $500 limit will often have a better credit score than somebody who has $8000 on a credit card against a $10,000 limit.
Don’t believe that because you’ve got a $10,000 limit, you should have excellent credit. Often the key is to have less owing.
Length of history.
Another factor is the length of your credit history. This may seem a bit unfortunate, but if you’re young, you may not have much credit history.
Luckily, the length of history is a smaller portion; it’s 15%. But if you don’t appear on any radar, Equifax doesn’t know how to rank you. Equifax will assume that you don’t appear because of bad reasons.
New lines of credit
People say don’t always call up for new credit cards. That’s because just the enquiry itself gets noted on your credit history, which is often is a red flag.
If you enquired about credit 10 times just because you were trying to find out what kind of credit cards you might be able to get, even if you didn’t intend to go through with it, that will negatively impact your credit score.
Types of credit
The last factor is the types of credit you have. If you have just one mortgage, you’re going to have a better credit score. But if you have a store card, a credit card, a personal loan, a car loan, a mortgage, a loan against your kitchen, and you have loans against three cars, six credit cards. That’s going to affect your score adversely.
Often, simplicity is best.
Lower credit limits, smaller debts against your credit limits, and a very tight payment history of always paying will positively impact your credit score.
How do you build up a credit history without getting into debt?
An excellent way to safely build your score is to get a credit card with a small limit on it. Pick whatever you think is comfortable, then halve it.
You want to be well within your comfortable limit.
Take that card, and purchase what you usually would buy anyway, and then pay it off on time. You’re now building that history of credit. You’re showing and proving to the algorithm that you can pay off credit.
You can use credit as a functional part of your life; pay it off, and you’ll have a great credit score.
So for a high credit score, don’t forget…
- Understand what impacts your score—various factors come into play, and some of them you can manipulate to improve your score.
- Pay debts on time—late credit payments have a significant impact.
- Keep your debts low—a low amount owing improves your score.
- Don’t enquire about credit you don’t need—enquiring about new lines of credit is noted on your credit file and can be looked at unfavourably.
- Build your history safely—you don’t need to buy extravagant things on credit to build your score. Get a small credit card, spend wisely, and pay it off quickly.
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This information has been provided as general advice. We have not considered your financial circumstances, needs or objectives. You should consider the appropriateness of the advice. You should obtain and consider the relevant Product Disclosure Statement (PDS) and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.
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