Whether you’re running a business, tending to your personal needs, or facing a financial emergency, you may find yourself in a situation where financial aid is the only option that makes sense. Borrowing money from friends or financial institutions isn’t anything new, especially for entrepreneurs.
It’s worth noting, though, that the bank or microfinance institution lends money according to creditworthiness. This factor is measured using the borrower’s credit score. The higher you score here, the more money you’re likely to be approved for, and at lower rates too.
However, despite its popularity, many people still don’t have a clear understanding of this aspect and how it can affect their borrowing ability. This article discusses all you need to know about building credit and improving your credit score.
What is a credit score?
Firstly, let’s understand what a credit score actually is. A credit score is a three-digit number assigned to you. It’s calculated via a mathematical algorithm based on detailed information about your credit history, such as; Payment history, total debt, age/type of credit and more (all of which we’ll look at in a moment). It was designed for risk management purposes, seeing as the idea behind it is to predict the potential risk you are to the lender.
It shows the lender what chances you have of potentially not paying back the money lent, credit given or service used and, this way, becoming a delinquent in the months after scoring and being granted credit.
Your credit score is calculated using many factors but in the end, it depends on the lender as well as your credit score, seeing as each lender is interested in different aspects about you. However, there are five major data points that go into a calculating your score.
- Payment history – If you’ve borrowed money before, the rate at which you repaid that amount will define your payment history. To get positive feedback, you must be good at repaying your loans. All the repayment transactions should be made on or before the due date unless you have any post-contract agreements with the lender.
- Amounts owed – Lenders will always want to know how much money you owe on other accounts, such as credit cards or to other banks, is of interest to new potential creditors. The available credit amount you are currently using is of interest to them too. If you currently owe a large sum of money, your chances of being approved for a loan are very slim.
- How long your history credit is – meaning how long ago you opened your first account or acquired your first piece of credit and time revolving around your account activity. A long credit history would usually mean you have been reliable in paying off your debts.
- What other types of credit you have – Do you other loans outstanding, a few credit cards, mobile phone contracts? They’ll check all of this to make sure you have been paying off the other debts in your name on time.
- New credit – In the pursuit of your new credit. This factor usually includes credit inquiries and the number of all the fairly recent accounts you’ve opened.
There are also some types of data that don’t affect your credit score and which you shouldn’t be worried about. These include your age, race, gender, marital status, address, and income. Creditors aren’t allowed to let these things influence their decision on allowing or denying your application.
Why is a credit score important?
To put it as straightforward as possible, your credit score will either make or break the deal with the lender you’re applying for credit with. It’s been found that not all companies offering credit will look completely at your credit score alone and some may even look past your credit score. Most creditors however, such as banks, micro-lenders, and financial institutions literally guide themselves by your credit score, low credit scores mean a no from them (sometimes)!
If you’re applying for a loan or credit card, and get accepted, your credit score will still play an important role in the application and will ultimately determine the interest rate you end up being charged.
The higher and better your credit score is, the less interest you will have to pay, both each month and overall because the lender will trust you to pay back the amount due as you’ve displayed the ability to do so before.
The other aspect regarding your credit score you might not have been aware of is that it affects other aspects of your life as well. Landlords, switching utility companies, and employers will sometimes take credit scores into account when looking into your history.
This means that, if you’re trying to open an account with the electric company, for example, and your credit score is bad, they will potentially ask you to make a higher deposit on the account. Or if you plan to rent a house or flat, and the landlord decides to look into your credit history, they can the refuse to rent to you based on your bad financial reputation (credit score).
How to improve your credit score
Given all the above and understanding just how important a credit score is, here are some of the best ways to improve yours.
- If you have been given credit (E.G. a credit card or credit account), never utilise more than 25% of your credit. Doing this will mean that you are always able to pay off your debt and not potentially leave yourself struggling after ‘maxing’ out your credit limit.
- Keep in mind that the way you utilize each account is very important and taken into consideration, as well as your overall debt-to-credit ratio.
- You could also consider a pre-approved credit card, open a new account, but don’t charge anything to it. This way, you will be able to increase your total credit limit as well as your credit score and not end up paying anything back because you never used the credit available to you.
- If you have any business cards, treat them like your own cards, they are usually jointly backed by the individual to whom they belong (yourself and the business). Keeping these down means nothing reflects badly on you.
- Never work with card issuers who don’t report your credit limit. Given the fact that these issuers don’t report the credit limit, lenders will calculate your credit score using the highest balance ever reported as a proxy for the credit limit. This basically means the lender will overestimate your usage of said card and, thusly, decrease your credit score.
- Negotiate the removal of certain negative aspects on your credit score. You might not think this is possible, but it is. You can actually ask a credit card company or any other issuer to have negative information removed from your account. If you just made a few errors in the past, they will normally oblige. If it’s more serious they may see it’s relevant to keep on record. You are their customer after all and so keeping you happy is number 1
- Do not neglect your student loan payments. Even if you’ve missed some (Which most companies understand), pay them all back as soon as possibly can. Afterwards, look to negotiate the removal of this little mishap from your track record.
- The longer you hold on to a credit card, the better it is for your credit score. If you positively need to close a few accounts, then close newer ones. Keep the old ones, as they show you are a serious and trustworthy payer. If you have an old account from a few years ago and a new account from this month, the older account will always look better on your record.
- Never max out your credit cards. As fun as it might be to have all this “free money”, it’s not actually free and you’ll probably struggle paying it back. Maxing out your cards is a very bad sign for any lender and it will definitely lower your credit score in the long run.
- If you’re looking to apply for credit with someone, try opening some credit card accounts. You don’t have to use them, but just having the accounts open can make you look more trustworthy when it comes to your finances.
- Make sure you’re on the electoral role for your address. This is used by creditors to verify you are who you say you are.
- Financially delink from others. If you’ve been in a relationship with someone and had joint finances etc, make sure you call or write to the credit reference agencies and ask for a notice of disassociation. This will stop their credit history affecting yours in the future. This isn’t do-able if you still have an open account with the person you split from, so make sure you pay off all credit between you.
- Minimise credit applications in short periods of time. Don’t apply for credit in numerous places in a short time space. If you get rejected from one creditor, use free eligibility calculators online to check your eligibility, they do this by performing a soft search, so it shows up to yourself on your credit report but not creditors.
- If you have and use a credit card, don’t withdraw cash from them. Keep everything on the card. Not only is it expensive to withdraw but lenders will see this as evidence of poor money management.
- If possible become an authorised user for a friend or relatives credit card account. You don’t have to use the account but again, being on the account and having it payed off on time at all times will help you both.
These are all amazing tips that do work and which will improve your credit score. However, keep in mind that, should it be bad, it cannot be fixed overnight. It will take some time until you reach the positive margin required to qualify for a loan. This is why it’s always a very good idea to never let your credit score go under at all.