Credit Scores and Why They Matter
What They Are
The credit scoring system was invented in the 1950’s, replacing the previous system of manually looking over each applicant’s credit report to determine whether or not they are granted credit. Credit scores can be looked at as an ankle weight to your road to financial freedom. The lower your score, the heavier the weight, and the slower you move. You can survive with a low credit score, but it won’t always be easy, and it will definitely won’t be cheap.
A credit score is a number that depicts a consumer’s creditworthiness. It is an indication of how well one manages their finances and whether they are able to repay loans in a timely manner. Financial institutions use credit scores to differentiate between good risks and bad risks (i.e. borrowers with high/low scores), and subsequently whether they want to ‘do business’ with the customer.
Your Score
The largest credit reference agency (CRA) in the UK, Experian, provide scores between 0 and 999. Whilst there is no “magic” number, generally, a credit score of 721–880 would be considered fair, 881–960 considered good, and 961–999 considered excellent. The other big CRAs in the UK, TransUnion and Equifax, use scores that range between 0–710 and 0–700 respectively. You can usually see your credit score or obtain a credit report for free on their websites.
The Calculation
The FICO Score, created by the Fair Issac Corporation, is the most commonly used credit scoring system by financial institutions. Whilst other credit scoring models do exist, a common blueprint is always used, but the data points fed into the credit scoring algorithm is adjusted depending on the credit bureau data available in each country. Generally, the 5 main factors that go into the creation of a credit score are as follows and in descending order in terms of weighting: Payment History (35%), Total Amount Owed (30%), Length of Credit History (15%), Types of Credit (10%), and New Credit (10%). These factors and their respective weightings will vary with different credit scoring models.
Importance of Good Credit
Establishing a good credit score will help make one’s financial life much easier. It offers: (i) access to more financial products e.g. better credit cards; (ii) lower interest rates on financial products e.g. loans; and (iii) higher limits on financial products, amongst other things.
In the past, one might not have had to care so much about maintaining a good credit score when they were not as important. However, in an increasingly intertwined society, things like your credit score are becoming more widely used everywhere. In addition to your score potentially affecting your access to financial products, you may find that credit scores also affect other aspects of your life. For instance, it is not uncommon for landlords, insurance providers, or employers to run a credit check on you to determine your ‘reliability’. This might affect your approval rate for rental housing, whether you get insurance discounts, or even whether an employer hires you.
Ultimately, having a good score will reduce your ankle weight, and allow you to move faster on your road to financial freedom. So, watch out for our next article “Building and Maintaining Your Credit Score”!
The content on this article is for informational purposes only. It should not be construed as legal, tax, investment, financial, or other advice. Nothing contained in this article constitutes a solicitation, recommendation, endorsement, or offer by Javia or any third-party service provider.
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Sources
https://www.hsbc.co.uk/credit-cards/what-is-a-credit-score. https://www.moneyadviceservice.org.uk/en/articles/how-to-check-your-credit-report. https://www.barclays.co.uk/help/credit-rating/credit-scoring/. https://www.equifax.co.uk/. https://www.experian.co.uk. https://www.transunion.co.uk/#consumer. https://www.investopedia.com/ask/answers/05/creditscorecalculation.asp. https://www.creditcards.com/credit-card-news/global-credit-scoring.
