What is credit? A guide to understanding credit

Credit allows us to borrow something of value, such as money, with the agreement it will be repaid over an agreed timeframe, often with interest.

What factors impact a lending decision?

There are many factors which lenders consider when making a lending decision. The credit score, an affordability assessment and the loan requirements (e.g. amount, term, purpose) are key criteria for lenders when deciding whether to offer credit to customers . This is also the information that the customer provides to lenders when applying for credit.

Affordability assessment

An affordability assessment is the process lenders use to decide whether a customer can afford to repay credit. The lender considers the customers financial circumstances, such as incomings and outgoings to decide whether they can make the required repayments over the agreed repayment period.

Risk based pricing

Risk based pricing refers to how lenders decide on the interest rates and loan terms they offer to borrowers, based on their creditworthiness. Factors that influence risk pricing include the amount of credit, the repayment period and the person’s credit score.

Credit score

Credit score (or credit rating) is a numerical scale which determines the creditworthiness of a person. It is based on the performance of previous customers with similar attributes.

An individual's credit score will be considered by banks and other lenders, when reviewing a credit application, such as for a loan. The amount lent and the interest rate, can depend on several considerations, including the borrower’s credit score.

A credit score ranks customers in terms of those most likely and most unlikely to repay credit. A higher credit score indicates a lower risk, so banks are more likely to lend to these customers. However, there is no definitive ranking, as different lenders use various criteria to determine a customer's credit score.

The higher the credit score, the better, meaning borrowers may qualify for more favourable rates from banks and lenders.

Credit checks

Your credit can be checked anytime you apply to borrow credit, this includes personal loans. There are soft credit checks and hard credit checks. Customer’s must give consent to lenders before a check is made.

A soft credit check doesn’t leave a permanent footprint on your credit record. It does, however, look at certain information to decide whether your application would be successful. Soft credit checks do not impact your credit score and are not visible for other companies to see. They can be carried out by companies checking your identity.

A hard credit check leaves a footprint on your credit report, usually lasting about 12 months. They can be performed when a person applies for finance, such as a loan. It involves a thorough check of the person’s credit report, to view the customer’s borrowing history and previous credit repayments. If a person’s credit report is subject to a hard credit check several times in a short period, this can indicate financial difficulty and harm their credit score – this may be a signal to lenders that the borrower is a higher credit risk.

A person can also check their own credit report, as their right to access data held about themselves. You can request a copy of your credit report every 12 months, from major credit bureaus, such as Experian, TransUnion and Equifax. Credit reports are also normally accessible on mobile apps via credit report/score platforms.

You can usually see ‘soft search’ inquiries on your report. Soft search inquiries will be displayed on their own section of your credit report. These are usually not a cause for concern as comparison sites and utility companies can carry out various ‘soft search’ inquiries when providing a quote and confirming your details.

‘Hard searches’ usually only occur when a full application has been submitted (for a personal or mortgage loan). These hard search inquiries are also normally listed in their own section, where you can see all hard inquiries from the last 2 years.

Why are credit scores important?

Having good credit is important when applying for loans, credit cards and mortgages. Banks and lenders are likely to refuse the application if they believe the borrower is unlikely to be able to repay the credit.

Other individuals and companies can also check your credit score, such as:

• Employers
• Landlords
• Insurance companies
• Utility providers

Although these do not provide credit in the same way as banks and lenders, they are still entitled to check your credit score, with your permission.

Some employers are legally required to check credit reports on potential employees, if the role involves the person dealing with finances. Employers also check reports so they can confirm you are who you say you are, as well as to see whether your financial situation may impact your work performance.

Letting agents and landlords can also check your credit report, to see if you have had any previous issues paying bills. They want to be sure they will be paid the rent by the prospective tenants . Insurance companies and utility providers can also request to check your credit report, to make sure you are able to pay your bills on time and in full.

How to improve your credit score

Having good credit can improve your chances of being accepted for different types of finance and loans. There are several ways a person can improve their credit score.

Repay on time and in full

Ensuring existing credit repayments are made in full and on time can improve your credit score – this shows lenders the borrower is reliable. Missing a payment is likely to negatively impact credit score. Any missed repayments can also remain on record for several years, although the recency and severity of missed payments is most relevant to lenders.

If an individual has never taken out any credit, this can make it more difficult for lenders to judge how committed and able they are to repay credit . In this case, customers with little or no history can start to build a credit history in a few ways. These include:

• Registering on the electoral roll
• Opening a current account and managing an overdraft
• Getting a credit card
• Take out a small form of credit like a mobile phone contract
• Managing utility bills

Limit credit applications

Multiple credit applications over a short period can negatively impact credit score, as this can indicate to lenders the person is struggling to manage their finances.

When comparing different rates for credit, a lender can request a quotation based on a soft credit search as part of the application, to show different rates. This is rather than performing a ‘credit application search’, so it won’t record on the credit profile or affect your credit score.

Review your credit report

You can request a copy of your credit report from companies like Experian, TransUnion and Equifax. It is worth checking through the report to make sure the recorded amounts owed are correct. Any mistakes could impact or delay a credit application.

What if there are errors on my credit report?

Although credit reference agencies hold data about you, whoever supplies the data to them is responsible for the accuracy of it. So, if your credit card provider has inaccurately recorded details about your account on your credit file, you should contact them to amend this.

You can also dispute inaccurate details with the CRA’s directly or be able to add a ‘notice of correction’ to your file, which allows you to explain what happened.

If you're unhappy with how your credit file is being managed by a lender or reference agency, you can address the issue with the lender or CRA. You can also contact the Information Commissioner's Office with your concerns if the issue isn’t resolved.

Register to vote

When lenders review a credit application, they will look for your personal details on the electoral register, such as name, address and previous address’. These details are required for the lenders to validate a person’s application for credit.

If a person isn’t registered to vote, this doesn’t mean their application is certain to be declined. However, it could cause a delay.

Why are my credit applications unsuccessful?

If your credit applications keep coming back as unsuccessful, this could be because you have a poor credit score. However, if your applications are unsuccessful even if you’ve never defaulted on anything, this could be due to other reasons.

There could be a mistake on your credit file. You can check your credit file with all three credit rating agencies, Experian, TransUnion and Equifax, to see whether there are any mistakes which could mean your applications have been unsuccessful.

Lenders can also check details on an application form against fraud databases, which can lead to a request being declined if someone has been guilty of fraud.

Criteria can differ between lenders. So, if your application isn’t approved by one lender, don’t worry too much. This doesn’t necessarily mean you won’t be successful with another.