Do you want to purchase a car or take out a loan but don’t know your credit rating? Or maybe you just need some clarification on what it is and how it affects your ability to borrow money.
Whether this is the first time you have heard of credit ratings or have had them mentioned before, understanding all aspects of creditworthiness can be quite daunting and confusing.
This blog post breaks down everything there is to know about credit ratings, why they matter, and how lenders use them when assessing if they should offer someone the financial support they require. Keep reading below to gain clarity around this important conversation!
What is a Credit Rating, and why is it important to know your score?
Your credit rating is a numerical representation of your creditworthiness or the likelihood that you will be able to repay loans and other forms of debt.
It’s based on your past borrowing behavior, including whether you made timely payments and if any defaults were registered against you.
The higher your credit score, the more likely lenders will view you as a good candidate for loans or other financial products.
Equifax and TransUnion—two of Canada’s major credit bureaus—produced the most common credit ratings, ranging from 300 to 900 points.
Generally speaking, anything above 600 demonstrates good borrowing behavior, while scores below 500 suggest potential risks associated with lending to an individual.
It’s important to track your score and stay on top of any changes, as a low credit rating can affect your ability to access the best interest rates or even be approved for certain types of loans. Moreover, lenders often use your credit score to indicate how much money they will lend you and at what interest rate.
A lower score may result in higher borrowing costs, while a higher one can lead to more favorable terms and conditions when taking out a loan or applying for a credit card.
A Brief History of Credit Ratings
Credit ratings or credit scores have been around for centuries and were first used in the 1600s to determine whether a person could repay their debts.
However, it wasn’t until the 1950s that Equifax and TransUnion began using more comprehensive scoring systems based on publicly available information about an individual’s financial history.
Since then, credit ratings have become one of the most important factors in determining if someone is eligible for certain types of loans, mortgages, or other forms of financing.
It’s now seen as a key indicator of how well someone can manage their finances and even be used by potential employers when making hiring decisions.
How are credit ratings calculated?
Credit ratings are calculated by considering several factors, including your payment history, the number of accounts you have open and how long you’ve had them, the type of credit used (mortgages, car loans, etc.), and any outstanding debt.
The information is obtained from the three main credit bureaus – Experian, Equifax, and TransUnion – whose job is compiling a report on your credit file. This information remains on record for 6 years in most cases.
Your credit score will be determined through a formula based on all this data. Some lenders use their scoring system or algorithm, which may differ slightly from the standard by major bureaus. Generally speaking, scores range from 300 to 850, with higher scores reflecting better creditworthiness.
How to check your credit rating?
Your credit rating is an important factor lenders consider when assessing your loan or credit card application. To understand how they do this, it is first important to check your score and investigate what information impacts it.
Most countries have free access to view your credit report, which will list all the elements that make up your credit score. It’s useful to check these regularly to identify any errors or potential areas where you could improve.
Alternatively, numerous online services allow you to pay a fee and get an accurate representation of how lenders perceive you.
Once you know the details of your current rating, look into improving it if necessary. This includes paying off any debt, managing your spending, and maintaining a good credit history.
How can you establish a credit rating?
1. Building Credit History
- Establishing a credit rating is all about establishing a strong and reliable credit history. It involves building up your ‘credit score,’ which lenders use to assess your ability to make payments on time and in full.
2. Credit Utilization
- The amount of money you borrow relative to the amount available affects your credit score, so taking out only a little debt about your maximum borrowing capacity is important.
Try not to exceed 30% utilization or more for any given loan product, i.e., if you have access to £10,000, try not to borrow more than £3,000 at any given time.
3. Pay Bills on Time
- Ensuring you are paying your bills on time, or even ahead of schedule, is important as it demonstrates good financial discipline and shows lenders that you can be trusted to repay a loan in full and on time. Any missed payments could harm your credit rating.
4. Monitor Your Credit File
- It is important to regularly check your credit report to ensure all the information is up-to-date and accurate. Also, ensure any accounts no longer used are closed down, as this will prevent them from being included when calculating your credit score.
5. Avoid Fraud
- Be aware of any potential fraud or identity theft and report it as soon as possible to the relevant authorities. Fraudulent activity can result in a fall in your credit rating, so ensure you are proactive in reporting suspicious activities.
6. Don’t Apply for Too Many Credit Products
- Applying for too many credit products could be seen as an indication of financial instability and could negatively affect your credit score. Instead, try to spread out applications over a longer period.
7. Seek Professional Advice
- If you need clarification on anything related to your credit rating or have general questions, seek professional advice from a financial advisor or other industry expert who can provide help and guidance.
8. Disputing Credit Rating
- If you believe your credit score is inaccurate, you can dispute it with the relevant credit reference agency to rectify any mistakes. This could improve your overall credit rating in the long run.
FAQs
Why is credit rating used?
Lenders use credit ratings to assess a person's creditworthiness, helping them determine if they can offer financial support. Borrowers must understand their credit rating when taking out loans or making large purchases.
What factors influence my credit rating?
Several factors can affect your credit rating, such as payment history, outstanding debt, length of credit history, type of credit used, and new credit inquiries. Maintaining a healthy credit rating is important to ensure all payments are made on time.
What can I do if my credit rating is low?
If your credit rating is low, you should take steps to improve it. This could include paying off existing debts, avoiding making too many credit applications, and setting up a regular payment plan for any outstanding debts. It is also important to regularly monitor your credit report to ensure accuracy.
Conclusion
Understanding your credit score and the importance of it can help you make informed decisions when it comes to borrowing money. Researching and understanding the basics of credit ratings can be overwhelming, but this blog post has broken down everything you need to know about what credit rating is, why they matter, and how lenders use them. Knowing your creditworthiness can save you from future financial woes and open up more borrowing opportunities.
