The essential facts about Credit Ratings

The essential facts about Credit Ratings
The Essential Facts about New Zealand Credit Ratings

A credit rating or score, is the measure of the ability of a borrower to pay back their loan based on previous loans or financial obligations.

My credit rating is something I have purposefully ignored knowing about for years, it’s just one of those horrible little things that creeps into your life and ruins all your fun. Like taxes. It’s admin that the world/the government/the Man, wants you to do, on their behalf, so that they can take your money away. Nobody wants that.

Sadly though, if you want a future that has assets in it that make you happy and comfortable like a car, a house (with a pool for the kids), and money for them to go to school… and maybe college, also for retirement, perhaps a second car…etc. You have to invest (ergh, another dirty word) some time in at least the fundamentals of your own finances.

Knowing about your own credit rating is useful as it can be used to evaluate your ability to repay your loans, which you can then use to improve your financial position, and keep the repo-men off your back.

The value of your credit rating is inversely related to your potential to default on your debt. What this means is, the more likely you are to fail to make loan repayments, the lower your credit rating will be. Changes in credit ratings of borrowers can affect the financial market as it influences how confident people are in certain lenders, such as banks.

How is your credit rating determined?

For individuals, the credit rating is conveyed by means of a numerical credit score that is calculated and maintained by credit-reporting agencies. The higher your credit scores the better your credit profile, which means lower interests rates charged to you by the creditor or money lender.

Your score is divided up into five categories: Payment history, amounts owed, length of credit history, new credit and the types of credit debt used. For different companies or lenders different factors are of more or less relative importance. Within the each category, certain details will be used to determine risk indicators for lending credit.

Length of credit history

  • Your oldest and youngest accounts and the average age of your accounts
  • How long your existing credit lines have been established for
  • How active your accounts have been

Types of credit you use

  • This includes home loans, car loans, private bank loans, study loans, rent, retail instalments finances from private lenders etc.

New credit

  • How many accounts you have opened recently

While an important factor, credit rating is not the only thing considered when applying for a loan. Your income, job, length of time spent at your current job, and the type or credit you are applying for are also taken into account. There are several varieties of credit score that creditors use, the principal one is FICO (Fair Isaac Corp).

Risk indicators

Certain aspects of your credit history or lending behavours, may impact your credit rating negatively, increasing your credit risk to the lender, which will ultimately increase your interest rates.

  • Opening a lot of new credit accounts in a short space of time
  • Paying your bills and instalments on time
  • A short credit history
  • Defaulting on payments
  • Short lived-accounts

A bad credit rating can affect other aspects of your life than just or ability to get more credit. A low credit score may induce a potential employer to scrutinise your past business habits more carefully and reconsider hiring you, as your low rating reflects poor reliability on your part as an employee.

Want to improve your credit rating?

If you have dug yourself into a financial pit of debt, it is in your interest to recover or improve your credit rating. A good credit rating will allow you to get a loan faster, for more money, at a lower interest rate. Ultimately, to ensure a decent rating you need to show that you are a reliable lender. However, like healthy trying to lose weight the healthy way, recovering your credit score can take a long time and requires discipline. Be patient.

Your credit rating is determined based on a publically available credit report that is generated by the credit bureau. Generally, you can request one for free online these day, from any of the main credit bureaus; TransUnion, Equifax, and Experian. Note however, that many other sites do offer free credit reports, but these are non-specific and you should be wary of giving out your personal information on such sites.

The first step is to read your credit report and make sure that the data in the report is correct. If it is not, you may have to dispute it with the credit bureau.

Second, you need to make sure your bills, loans and instalments are paid on time. Set reminders for yourself, on your phone, email or calendar, or better yet, go to the bank and arrange a debit or stop order to pay your accounts on the same day each month.

Third, you need to minimise the debt you already owe. Stop using those shiny credit cards and cut them up (or just hide them in a safe place). Next, start paying off that debt, apportioning most of the payment to accounts with the highest interest rates.

If you have missed or are late with any payments, pay those bills as soon as possible and try to keep current. If you are not managing to make ends meet then it is recommended that you see a credit counsellor to advise you.

Tips & Facts

If you are planning to make a big purchase, in which you need to apply for a car or property loan, you may want to ask the company for the type of scores they use, so you can determine exactly, how your credit rating will affect you on this purchase. Don’t feel shy about asking about this, you need to know how your credit score will affect your purchase and future purchases or loans.

If you are planning on getting married or sharing a life with someone, it may be useful to take a look at each other’s credit reports to work out what you will collectively owe, how to pay it off and how it will be factored into your budget.

Know that your credit score is not the only thing that determines whether you will receive a loan. Different companies and financial institutions use different indicators to decide on worthiness to receive credit. Factors such as your income, employment history, age, net worth and lending history may also be taken into account and are weighted differently in different companies. For example, you may have an exemplary credit rating but have an irregular employment history (maybe you are a freelancer, or work by contract for IT companies), so you may be denied loan approval because the lender does not see any proof that your income can support your loan payments.

You can get a free FICO credit rating from: http://www.myfico.com/fico-credit-score-range-estimator/