Why is a credit score important?

When it comes to lending you money, lenders won’t take you at face value. A lender wants to make sure that you will pay back the money you have borrowed, and you won’t default on your loan. In addition to your income, expenses and personal situation, a lender will consider your credit score. A credit score will have a big impact on whether a lender approves your loan and how much they are willing to lend you. Whether you know it or not, you have a credit score, but what is it, what influences it and why is it important?

What is a credit score?

A credit score is a number assigned to an individual based on personal information collected by a credit reporting body. National credit reporting bodies in Australia collect information from financial institutions to create a report and individual credit rating. Your individual credit report includes personal information such as your age, credit history, repayment history, along with any debt or history of insolvency. Using data in your credit report, a credit reporting body gives you a credit rating or individual credit score.

A credit score is a number between 0 – 1000 or 0 – 1200, depending on the credit reporting agency. This number, based on analysis of past behaviours and current circumstances, communicates to a lender the risk involved in lending you credit – how likely is this person to repay their loan? A high number indicates a good credit score and equates with low risk for the lender, while a low number corresponds with a bad credit score and positions the individual in the ‘high risk’ category. A credit score is dynamic which means it changes as your financial situation changes.

Why is credit score important?

A credit history check is a standard part of credit applications. Whether it is for a credit card, personal loan or home loan, a lender will look into the credit history of the applicant. A credit check involves a lender looking at an individual’s credit report and subsequent credit score. Credit scores are categorised into five different groups starting with below average at the bottom, followed by average, good, very good and excellent at the top.

A good credit score is important because lenders rely heavily on a credit score when making decisions about credit applications. A credit score will influence:

• if a lender approves your loan application
• how much a lender is willing to lend you
• the interest rate at which a lender will loan you money
• the financial product or service that is available to you

Do I need a good credit score to buy a property?

A property is usually the biggest purchase a person will make, and for most people, a home loan is needed to make it happen. If you require a home loan to purchase a house then a good credit score or credit rating will be helpful when obtaining a home loan, but it is not absolutely necessary.

As previously mentioned, your credit score plays a crucial role in any home loan application process. A good credit score will show your lender that you are a responsible applicant and based on your past behaviour they can expect loan repayments to be repaid on time. It’s a big tick for lenders and a positive step towards buying your own home.

Aside from loan approval, a good credit score has the power to secure you a better deal. With a good credit score on your side you may be able to negotiate a lower interest rate. Those with a low credit score do not enjoy the same bargaining power. Lenders will not be so willing to negotiate with someone who has a low credit score. Often applicants who have a low credit score will incur a higher interest rate and fees as the lender is taking a far bigger risk in loaning them money.

While those with a good credit score can take advantage of a competitive loan product to help them buy a house, those with a poor credit score may have access to a very limited range of home loan products. Bad credit loans offered by non-bank lenders allow those with bad credit to buy a house and get their credit score back on track. Bad credit loans usually attract a higher interest rate and fees, but often these loans can be reviewed after a period of consistent repayments and the borrower may be offered a better deal.

How do I get a good credit score?

In July 2018 the Australian government made it compulsory for lenders and credit reporting bodies to adhere to a comprehensive credit reporting system. This credit reporting system means both positive and negative credit history are included in a credit report and both contribute to an individual’s credit score.

The previous reporting system only recorded negative information, also known as a ‘black mark’, such as a default on a repayment. Credit reports did not record good credit behaviour. To maintain a good credit score you just had to avoid any adverse events. This did not serve people well if they consistently exhibited good credit behaviour, but adverse events lead to a single ‘black mark’ on their credit history.

A comprehensive credit reporting system means that even if you have a ‘black mark’ on your credit history, you can still take positive steps toward building a good credit score. Achieving a good credit score requires an individual to be diligent and take control of their finances.

To get a good credit score you should:

• Ensure you make all credit repayments on time (you can set up direct debits and schedule loan repayments)
• Reduce your credit card limits
• Pay off your credit card in full each month
• Keep credit to a minimum – limit the number of credit cards you have and only apply for credit when you need it
• Consider consolidating your loans if you have multiple personal loans or home loans
• Pay at least the minimum repayment amount on home loans or personal loans
• Talk to your lender early if you are unable to meet repayments so alternative arrangements can be made

What else is important when buying a house?

In addition to your credit score, a lender will consider your income, expenses, family situation and employment. It is important to be accurate and transparent when you disclose these details to your lender. If a lender finds out you have provided false information they can reject your home loan application and the mere enquiry on your credit history is enough to contribute to a lower credit score, particularly if you then apply for a home loan with another lender.

When you are buying a house and applying for a home loan, it is the lender’s job to determine if you can service the loan. This means looking at your income, expenses and family situation to determine if you will be able to repay the loan. If you provide misleading information or deliberately withhold information in order to increase your borrowing capacity, you may struggle to keep up with repayments. This can lead to missed repayments and in the worst-case scenario you may default on your home loan.

Even with a good credit score your income, expenses, family situation and employment may be unfavourable, so it’s important to consider all aspects of your situation. In the same way, favourable circumstances such as your income or equity may help to outweigh a low credit score.

Another important thing to consider when buying a house is the number of times you apply for a conditional or pre-approval or home loan. Each time you apply for a conditional approval, pre-approval or a home loan a lender will check your credit report and credit score. This is called a credit enquiry and the details of each enquiry are recorded on your credit report. Credit enquiry details will include the lender, the loan that has been applied for, the amount and date. Multiple credit enquiries are taken as a sign that an applicant is under financial strain. It is therefore advisable not to apply formally for a conditional approval, pre-approval or home loan until you have decided on a lender and intend to continue the home loan process with them. Any credit applications or pre-approval applications should be in line with your objectives, financial situation and personal circumstances.

How will a home loan impact my credit score?

A credit report records your entire credit history including lenders you have used, loans you have applied for, the amount you have borrowed, open and closing dates of accounts and your monthly repayment history. This means that your home loan and the way you manage it will impact upon your credit score.

If you manage your home loan responsibly then it can have a very positive impact on your credit score. If you consistently make home loan repayments on time and ensure you do not miss a payment, these positive actions will be considered when determining your credit score. Even if you have a ‘black mark’ on your credit report, consistently making repayments on your home loan and demonstrating good credit behaviour can help to improve your credit score.

In the same way that positive action can improve your credit score, negative action such as missing repayments or defaulting on your home loan can lower your credit score. In this way a home loan may negatively impact your credit score. It will be important to manage your home loan responsibly and notify your lender as soon as possible if your situation changes and you are unable to meet repayments.

Where can I calculate or find my credit score?

Credit scores are calculated by national credit reporting bodies (CRBs) in Australia. The major credit reporting bodies are Experian, Equifax and Illion. Lenders will use these credit reporting agencies to check your credit score and credit rating, but you can also check your credit score and credit report for free, either directly through a credit reporting body or using an online provider.

There are a number of online credit score providers including CreditSavvy, Finder, Credit Simple and Get Credit Score. Your credit score may vary depending on which credit reporting agency has been used. It is therefore important to check your credit score with multiple providers to give you an accurate measure of your credit score. It should be noted that if you check your credit score with some providers they will share your personal details with third parties for marketing purposes. Read through their terms and conditions before you check your credit score.

Checking your credit score will not have a negative impact on your score. It is actually important to check your credit score to ensure all details are correct. If you check your credit score you should ensure all personal information is correct and there are no credit applications that you do not recognise.

So, what are you waiting for? Check your credit score and start planning to improve your financial situation, whether it’s increasing your credit score or negotiating a better deal with your lender.