Understanding How Credit Rating Works

Do you know that you’ll be paying more in interest if you have a bad credit score? Do you also know that it’s often difficult to find a suitable personal loan if your credit rating is less than perfect? Such are the consequences if you’re not deliberately careful with keeping your score on the good end of things. Your credit score may just be a number at the end of the day but it can wreak havoc on your finances.

You don’t want to wait until it’s time for you to purchase a car or house before you take time to understand how credit rating works. In fact, there’s no better time to know more about the matter than now. And to help you do just that, here’s your quick guide to credit rating:

What is a credit rating?

Your credit rating is determined by a credit-scoring company based on information and data from major credit-reporting agencies in the UK. To represent your credit rating, you are given a credit score, which can fall within different categories – bad, fair, good and excellent. Your credit score will depend on the scale used. If your score is calculated using the FICO scale then getting a score of 700 to 850 is good while a score of 300 means you’re work is cut out for you.

 

How is your credit score calculated?

If we’re sticking with the FICO scale then your credit score is calculated based on five key elements, which are:

  • Payment history – One of the first things credit agencies look at when computing your score is your payment history. It’s also the first thing your lender looks at to determine your creditworthiness. Payment history is 35% of your credit and it’s also the most critical aspect you need to focus on if you’re in the process of boosting your score.
  • Amounts owed – The total amount of debt you owe including personal loans, credit cards and more is another key element that affects your credit score. This element is 30% of your credit score.
  • Length of credit history – The longer your credit history, the better your credit score will be. At least that’s how it works in general. If you’ve been using credit cards for long, for example, and you’re a good payer that translates to positive effects on your credit score. Credit history is 15% of your credit score.
  • Credit mix – When calculating your credit score, the mix or diversity of your credit accounts is also considered. Though just a small 10% of your score, it would help if you have a diverse mix of retail accounts, credit cards, installment loans and more.
  • New credit – Finally, if you have new credit accounts that’s 10% of your credit score. If you’re planning to open several new accounts in a short period of time, you might want to rethink your decision. Having new accounts in just a short time pose greater risks on your credit score in general.

 

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How does your credit score affect you financially?

Let’s say you’re applying for a personal loan. Your lender will look at your credit rating or your credit score not to determine your ability to pay but how much risk you pose as borrower. Even if you have sufficient income and your outstanding balance is minimal, your lender may think twice lending you money if your track record is unimpressive. If your payment history, for example, is really bad, then you’ll either get a rejection or your personal loan will come attached with a heftier interest rate than if you have an excellent credit rating.