Credit 101 – What Is It And How Does It Work?
According to surveys, two thirds of Brits have no idea what their credit score is. More worryingly, more than half don’t actually know how much they owe on credit cards and loans. There are a lot of reasons for this, but poor financial education in schools has been one of the more common explanations. This has led to a lot of people not really understanding what credit is, how it works, or how it affects their lives. But since it is such an important part of your life, and can influence a lot of things, we wanted to go back to basics, and go through credit 101.
What Is Credit
Let’s start at the beginning – credit is an agreement you have with a lender to obtain goods or services that you pay for at a later date, under agreed terms. For example, if you get a loan, the lender will give you the money you request, and you will have to repay that loan over a pre-set period of time, along with interest and possibly other fees. Credit cards, mortgages, vehicle finance and even standard loans are all forms of credit.
In order to work out if they should lend money to you, lenders will look at your credit report and your credit score.
How Does Credit Scoring Work?
Your credit score is a number, and it can have a huge impact on your life. Your credit score will affect any application you make for credit – from loans and mortgages to credit cards and car finance, so it’s important to understand it.
Your credit score isn’t worked out by one person plugging numbers into a computer. Instead it’s complied by separate credit reference agencies, who then inform your lender about your previous history with credit For example, how quickly you’ve paid back what you borrowed, whether you have any outstanding debt, whether you’ve made late payments and so on. The lender will then assess how suitable a borrower you are for whichever product you have applied for.
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 work out what kind of borrower you are, and how much of a risk you pose. This means if you have good credit, you will likely be approved, and if you have bad credit you may be denied.
What Is A Credit Report?
A credit report might sound similar to credit scoring, but there are some subtle differences – not least the way you interact with it. Your credit report contains a history of your dealings with credit, and most people will have four – one for each of the national credit reporting agencies in the UK (Experian, Equifax, Crediva and TransUnion). Your credit report contains a detailed list of all accounts you’ve opened and closed in the recent past, along with how you’ve managed each. In this, you will be able to see every missed payment, any account that has been sent to collections, and how that impacts your credit. It will also list other relevant records, like bankruptcies, foreclosures, repossessions and other information that could be a red flag to lenders.
But it’s not all doom and gloom – it also shows all of your on-time payments and longstanding responsible credit use, which works in your favour. And finally, your credit report lists your basic information – name, aliases, misspellings reported by creditors, current and past addresses, National Insurance number and any recent credit checks that have been run on you.
What Is Good And Bad Credit?
Generally, you will fall into one of three camps – good credit, bad credit, or somewhere in between. This will depend entirely on your credit score, and a good one can open up a lot of opportunities when it comes to getting credit (and better deals on credit). There are 2 scoring systems for credit, with slightly different ranges. They look like this:
- Exceptional: 800 to 850
- Very good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
- Excellent: 781 to 850
- Good: 661 to 780
- Fair: 601 to 660
- Poor: 500 to 600
- Very poor: 300 to 499
When you check your credit score using one of the services we’ve listed above, you will see a number score, along with what that means. If you see it’s not quite in the good range or above, you should consider taking some steps to improve it.
How Do You Build Credit?
The good news in all of this? You have complete control over your credit score, and there are some things you can do to improve it. Establishing a solid, positive credit history can take time, effort and a lot of patience, but it’s worth it in the long run. A few ways you can build good credit include:
- Use credit regularly
- Establish a positive payment history
- Keep your credit card balances low
- Borrow wisely
- Keep track of your credit score and reports, and fix any issues as soon as you see them
It’s never too late to work on building your credit, and the longer you have before you need good credit, the simpler it will be. Regardless of how many negative items you have on your credit report, their impact can and will diminish over time as you add new, positive information. It’s a long game, but an incredibly important one to play if you want to achieve financial security in the future. For more information about credit, how it could impact you and what to do now, just get in touch with our team today.