Credit report and credit score
A clear explanation of your credit score and how it affects you
When you apply for a loan the lender will need to make an affordability decision, which influences your likelihood of being approved. To make an affordability decision the lender will take into account a number of different information sets such as your age, employment details, residential situation and so on. For all unsecured loans, your credit score will play a major role in the affordability decision. Banks, payday lenders, personal loan lenders, insurers, credit card issuers and even car retailers decisions will be influenced by a credit score.
What is a credit score?
In the simplest term, your credit score is a prescribed number that indicates to a lender your ability to repay a line of credit.
Who generates your credit score?
A credit score ranges from 330 to 850. Each bureau’s score will vary slightly but the difference in the score should not be significant. The higher score you have the better your credit rating and the higher probability you will have of being accepted for a loan. A higher credit score will also improve the interest rates you pay, meaning lower monthly payments. As a general indicator:
- 750+ = Excellent Credit: You will receive the lowest rates on the market and other benefits.
- 720 – 749 = Very Good Credit: You will probably be approved for any loan program you choose.
- 680 – 719 = Good Credit: You have paid most of your bills on time and performed well with previous loans. You will likely to eligible for prime financing with solid interest rates.
- 620 – 679 = Ok Credit: You may struggle to be approved for financing and, if approved, will be offered higher interest rates.
- 619 and Below = Very Poor Credit: You will struggle to get an unsecured loan and may need to opt for a secured financing option where your assets will reduce the lending risk for the provider.
What influences credit scores?
A lot of significance is given to your credit score in the consumer finance market. You will often be told you must have a good credit score be to get the best deals, be approved for lines of credit and have a chance of getting a mortgage. So, what exactly goes into deciding your credit score and how is it calculated?
FICO is the major player in credit scoring. They have developed a unique and guarded algorithm that calculates your credit score from your financial history. They take the information within your credit report (provided by credit bureaus) and break it down into 5 distinct categories. Each of the 5 categories plays a role in determining your final score, with some weighted more heavily than others. Here is a breakdown of the 5 categories and their weighting.
1. Payment History (35%)
Your payment history plays the largest role in determining your credit score – specifically the repayment of past debt. According to FICO, your previous payment performance is a good indicator of your future payment behaviour, i.e. whether you are likely to repay a line of credit. The type of credit will also play a role in this category. For example, FICO suggests that a failed payment on a larger loan such as a mortgage will impact your credit score more severely than a smaller loan type or credit card.
To keep your score healthy, you should consistently pay your debt on time.
2. Credit Utilisation (30%)
Credit utilisation is the percentage of credit used that is available to you. For example, if your total credit limit on your credit cards and loans was R25,000 and you used R5,000, your credit utilisation would be 25%. FICO suggests that customers with the best credit scores tend to average around 7% credit utilisation, with 10-20% being OK.
This figure is seen as important as it is believed that individuals who are consistently close to their credit limits cannot handle debt responsibly.
As you can see, payment history and credit utilisation combine to make up almost two-thirds of your credit score. If you can keep your credit card balances low and make payments on time, you are on your way to a good credit score. The remaining categories look at how long you have managed credit, what credit you recently applied for and the variety of credit you have handled in the past.
3. Length of credit history (15%)
This category looks at the length of time your credit accounts have been open and the time since they were last used. This does mean it is almost impossible for new credit users to have a perfect credit score because they do not have enough previous financial activity to forecast future behaviours accurately. Our advice for new credit users would be to begin using a line of credit to build your history whilst existing credit users should maintain long-standing accounts, as it will be beneficial to your credit score.
4. New Credit (10%)
FICO suggests that applying for too many lines of credit in a short space of time could negatively affect your credit score as it suggests you may be in financial trouble and need access to money. It is recommended that you apply for credit when it is needed and in moderation.
5. Credit Mix (10%)
The specifics of this category are less well outlined, however it is believed that a consumer with a variety of credit in their history will have an improved score as it demonstrates they are capable of handling different types of debt. FICO indicates that consumers with a variety of revolving credit and instalment loans in their history prove less of a risk to lenders.
This breakdown should give you a better understanding of how your credit score is formed and where to pay particular attention if you wish to improve your rating over time.
What if I have a bad credit score?
If you have a bad credit score it means you have not performed well in the past with financial commitments. You may have repaid bills late and/or defaulted on previous loan or credit card payments. You will need to work on improving your credit score before applying for additional lines of credit.
How can I improve my credit score?
Improving your credit score will not happen overnight. Credit Bureaus will need to see a consistent improvement in your overall financial behaviour before your credit score increases. Luckily, there are a few things you can do to help improve your credit score.
- Make sure you repay your existing loan(s) on time and meet the monthly payments.
- Keep up to date with credit card repayments each month.
- Keep on top of your bills and pay them on time.
- If you do need to take out another line of credit, make sure the monthly repayments do not over-extend your finances. Defaulting on payments is not a good idea.
- If you are struggling to make payments, talk to your credit provider. In most cases, they will work with you to agree on an alternative payment plan that you are able to meet.
- Do not ignore the demand for payment.
- Secured credit cards can be a useful way to rebuild your credit. The money on the card is transferred from your bank account, meaning you are not taking out credit, and the repayments will be reported to the credit bureaus. Meeting payments will reflect positively on your credit score.
Why you should monitor your credit report
Detect identity theft early
About 76% of South Africans feel that identity theft is more likely to take place than ever before. Therefore, the sooner you’re aware, the sooner you can take necessary action. The three major credit bureaus in South Africa: Experian, TransUnion and Compuscan all provide credit monitoring services, so you could be alerted after someone attempts to open a new account using your personal details.
Unveil mistakes in your credit report
Unfortunately, mistakes do happen – even with the credit bureaus. According to the Credit Bureau Monitor, of all credit reports issued in Q4 2015, over 17% were challenged for alleged inaccuracies. Of these disputes, nearly two-thirds were resolved in favour of the consumer. If you do spot what looks like a mistake in your report, you can immediately take up the matter with the credit bureau directly.
A good example being if you hold a credit card with another authorised user on the account and they miss a payment, you could receive an alert for that. You can also receive alerts for positive changes, such as your credit score going up a few points resulting in it going from good to excellent. That’s an alert worth getting!
Know who's viewing your report
Another added benefit is that a credit monitoring service can inform you whenever another company or person requests a copy of your credit report. Perhaps you requested a credit limit on your credit card or are looking to take out a new mobile phone contract. The majority of the time these requests are legitimate, although it’s good to know if anybody you don’t recognise is looking at your report.