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How does credit scoring work?

Your credit score affects any application you make for credit from loans to mortgages to credit cards - but how exactly is your score worked out? We take a look at who decides your credit score and what you can do about it.

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What is a credit score?

Nowadays credit scores and ratings are something that we are more aware of than ever. Not least because the credit crunch made more people apply for credit, yet more are being rejected because of the banks' need to cut down on lending.

This can make it seem like our applications for credit are being refused left right and centre, whether we make them for a loan, mortgage, or anything else.

Credit scoring means that whenever an application for credit is made, data is pulled together on your past credit behaviour in order to help the lender determine what sort of borrower you are. However, it is important to remember that you don't have one independent credit score which is arbitrarily tapped into a computer to decide your credit worthiness.

Instead, your score is compiled by separate credit reference agencies who inform your lender about your history with credit - for example how quickly you have paid back what you've borrowed, whether you have any outstanding debt, and so on. Lenders will then assess how suitable a borrower you are for whichever product you have applied for.

Lenders use the information that credit reference agencies provide them with to predict what sort of borrower you will be. This might give the impression that you're marked with a number from 1 to 10 that states whether you are a 'bad' borrower through to a 'good' borrower. In reality your credit file is simply some data held about you that reflects your history with credit, and can give your lender a picture of how high-risk (and sometimes how high-profit) a borrower you are.

What makes up my credit score?

A credit score is made up by information held by credit reference agencies, which lenders use to determine your suitability for a product. But what data do banks use to make up your score?

Your application form

First and foremost you will have filled in an application form for credit. This is likely to include all the relevant information your lender needs relating to your income, employment circumstances, address, and so on. Although some of these details are only a formality, factors such as your income can play a part in how credit-worthy you appear - simply because if you are on a lower income, you are more likely to have trouble repaying the credit.

It is very important to get all your details down correctly at this stage, as lenders use this as a starting point in predicting what sort of borrower you will be. So make sure you fill everything in correctly and are as honest as possible about your circumstances.

Your past behaviour with the lender

This applies if you are seeking credit from a lender you have already had business with; for example, if you are a customer of a bank, your financial circumstances can be looked at, and any past credit agreements can be checked. Even if you have not had previous business with the lender, your credit behaviour will still be held by credit reference agencies and so will be looked into.

If you have borrowed and repaid with banks successfully in the past, you are more likely to be seen as credit-worthy now - but if you have had a history of late payments, your application for credit will be looked on a little more sceptically.

Credit Reference Agencies

There are 3 main credit reference agencies in the UK who each hold information on your past credit behaviour. These are Equifax, Experian, and TransUnion.

When you make an application for credit, data from these reference agencies will be pooled together to build up a picture of you as a borrower - but what data will be held on you?

First it's important to note that most of the data in your file will only go back 6 years. This means that the way in which you've borrowed and paid back in the last 6 years will be looked at primarily, without regard to your history before that point - although generally a history of bankruptcy or CCJs will be looked at too, however long ago they occurred.

  • Electoral roll: The electoral roll verifies your permanent address and informs your local council that you are able to vote. This information will be used to confirm your address, how long you have lived there, who you live with, and other residential details that the lender is interested in.

  • Court records: Any appearances in court you have made to do with debt or bankruptcies, and if you have any CCJs (County Court Judgments).

  • Other lenders: A record will be held of other lenders who have searched your file. If you have lots of these it may indicate that you have made lots of applications for credit recently, giving the impression you are very much in need of it and therefore more of a 'high-risk' customer.

  • Financial associations: Anyone that you have had a joint credit agreement with in the past, such as if you had credit card with a partner, will be recorded. Where your partner's credit history has been less than pristine this could affect you.

  • Frauds: If you have committed a fraud with credit usage in the past this will be recorded.

  • Credit Behaviour: This includes all the transactions you have had with banks and building societies such as loans, mortgages, bank accounts, credit cards, and so on. This will show what your general behaviour is when it comes to dealing with your finances, if you have repaid your debts on time and whether you have a history of missed, defaulted or late payments.

Using all this information your prospective lender will then decide your suitability for the product you have applied for. This means that you do not have a credit score that you carry around with you as such, just a collection of information that can be used to assess your credit-worthiness when necessary.

In this way it's important to be able to generate a healthy credit score, so that if you are ever in need of credit such as a loan or credit card, it will be available to you. Even if you like to keep away from credit and only spend what you have, it's always useful to have a good financial grounding in case you need credit in an emergency.

How do I find out my credit score?

It is possible to look at the information held on you by credit reference agencies to see what kind of scoring you might be given by a prospective lender. To do this you can apply online to ExperianEquifax or TransUnion to see your credit file, although this often involves a fee.

You can also purchase a summary report from all 3 agencies by going to Checkmyfile, which will give you a good idea of the sort of information held on you. This will give you a chance to check that all the information is correct. It's worth looking at the data held on you by all 3 agencies, as generally lenders will use a combination of 2 or 3 of the agencies to gather information.

As well as having an impact on whether or not you can secure credit for mortgages, loans, credit cards and so on, your credit scoring can also affect what sort of interest rate you are offered on any borrowings. If you are seen as more of a high-risk borrower, it's more likely that you will be required to pay a higher rate of interest on your debts than if you were seen as more low-risk.

In this way it's important to make sure the credit information held on you is correct and as healthy as it can be. If you're having trouble securing credit it is possible to improve your credit rating by always making sure you make repayments on time, and spacing out your applications for credit in the future.