How the credit ratings agencies know your worth
We all know how important it is to check your credit rating, and that having a decent score will improve your chances of being able to borrow at the best rates. But the link between your credit score and your ability to borrow is more complicated than it first appears; indeed, your credit report is just one set of information used by banks, credit card providers and other companies when processing loan applications.
Lenders in the UK are only required by law to give their best advertised rates to 51% of people. The remaining 49% (usually those with poorer credit scores) can be offered inferior rates.
Part of the opacity between credit scores and whether you’ll be accepted for the best deals is because in the UK, unlike the US, companies typically use bespoke scoring systems to decide who to lend to and at what rate. They’ll take information from your credit report – not just the score, but the information that it’s based on – and from their own databases and other sources, and then run complicated calculations to guess how likely you are to repay.
In theory, this variety is a good thing. It means different lenders can accommodate different sorts of borrowers, but in practice it means it’s hard to know if you’re likely to be accepted for the best deals before you apply.
Justin Basini, founder of ClearScore, says: “It’s true that each lender has its own system for assessing creditworthiness, and these are kept secret.
Because lenders will never reveal exactly how they decide on whether or not to lend to someone, your credit score is still the best approximation of whether you’ll be accepted.”
This lack of universal standards can also lead to credit rating agencies giving mixed messages on the best way to improve your score.
For example, getting rid of credit cards you don’t use any more is a good idea to improve your score, says Lisa Hardstaff, credit information expert at Equifax: “If you’ve already got £40,000 credit, lenders might ask why you want another £10,000.”
Experian’s James Jones agrees, but adds that using too much of the credit available to you can also be damaging: “In our experience, it’s a good thing to have low utilitisation [using a small amount of your available credit]. The fact you’re not reliant on it shows you are creditworthy.”
Companies using private databases create other, more subtle, issues for the consumer. If you apply for a loan with your bank, it will probably factor in how you’ve used your overdraft when making its decision. But this information isn’t necessarily shared with credit rating agencies, and your bank may be more or less willing to lend to you than other companies as a result.
Younger would-be borrowers are most likely to be affected by this. Just one quarter of people user 25 have a credit card, according to the UK Cards Association, and the majority haven’t used traditional loans either.
When they come to get a mortgage, they may have a good track record of managing an overdraft, they may have a good track record of managing an overdraft, but only their current account provider will know. That could restrict their ability to borrow elsewhere, and few of the best loans and mortgages are offered by high street providers.
Student loans don’t help build a credit score either, as they’re not tracked in credit reports.
That said, it’s not just information from banks and credit card companies that affects your credit score. Utility and mobile phone bills are also types of credit, as most people don’t pay their bills in advance. According to Experian, one in eight data points on a credit file come from communications and utility companies. Yet, in some cases the information lenders use to make decisions has nothing to do with your finances.
Social media and browser data
In August, Facebook secured a patent that gives someone a credit score based on the scores of their contacts. In the words of the patent application: “When an individual applies for a loan, the lender examines the credit ratings of members of the individual’s social network who are connected to the individual through authorised nodes. If the average credit rating of these members is at least a minimum credit score, the lender continues to process the loan application. Otherwise, the loan application is rejected.”
The idea that your credit score could be affected by your friends’ behaviour is scary stuff, although there’s no suggestion that this technology is in use yet. But several companies are using social media and other digital information to process credit applications in different ways, and they’re all very secretive about the process.
Moneywise spoke with Paul Thomas, managing director at Provenir, a software company that automates the decision-making process for lenders. He explained that at the most basic level, social media information, or information from your computer when making an application, can be used to combat fraud using location data. “If you say you’re in TW9 but the loan application has come from Thailand, that’s suspicious.”
More advanced analysis of social media is most likely to be in situations where lenders don’t have much information on the borrower, or where someone narrowly falls short of the lending criteria, to see if an exception can be made.
It could include things like verifying the information in your application based on your Facebook or Twitter profile, such as your job, though it’s possible for companies to build much more sophisticated models. They could, for example, see what you’ve been saying on Twitter – boasts of late-night gambling wins, or demonstrations of conspicuous consumption, are unlikely to improve your chances of getting a loan.
Does a good score mean you'll get the best products?
Even if you have a good credit score, there’s no guarantee you’ll get the best products. Indeed, it’s not even clear what a ‘good’ score is.
An ‘excellent’ credit score, which is 549 or higher in Equifax’s system, might be enough to get the best deal with one provider, but not another, and you won’t know for sure unless you’ve applied and are accepted or rejected.
Some comparison sites will let you run a ‘soft search’, which gives you an indication of whether you’ll be accepted or not without affecting your credit report, but it’s not infallible.
As we’ve seen, lenders only need to offer their advertised rates to 51% of successful applicants, and these advertised rates are what most people look at when taking a loan or a mortgage. But as lenders don’t need to say how many applicants they accept, these rates might only be offered to people with the very best scores.
And worse than that, some lenders might reject you even if you have a perfect borrowing history. Savvy shoppers who make the most of 0% purchase or balance transfer deals aren’t profitable for credit card companies, and there are concerns that information from credit rating companies is used to identify and reject these borrowers.
However, this point is disputed by the credit rating agencies. Jones says lenders aren’t allowed to use information from credit reports to make ‘marketing’ decisions, which are influenced by profitability.
Remember, you can access your credit report for free at Noddle.co.uk. Plus, if you find your record contains incorrect information, notify credit agencies so they can correct it.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Your credit score is a three-digit number (ranging from a low of 300 to a high of 850) calculated from the information in your credit report. Your credit score enables lenders to determine how much of a credit risk you are. Basically, a low credit score indicates you present a higher risk of defaulting on your debt obligations than someone with a high score. If you have a low credit score, any products you successfully apply for will carry a higher rate of interest commensurate with this risk.
A report containing detailed information on a person’s credit history, a record of an individual’s (or company’s) past borrowing and repaying, including information about late payments and bankruptcy. It also includes all applications a person has made for financial products and whether they were rejected or accepted. Your credit report can be obtained by prospective lenders to determine your creditworthiness.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.