Everyone has a credit score. That score is used by a range of organisations for a number of different reasons.

Some people have a good credit score and some people don’t . Obviously a good credit score is better than a bad credit score. If you have a really bad credit score it can make life difficult for you.

Did you know due to a new law you can now get your credit score free for life?

So what is your credit score, how is it calculated and what can you do to ensure that you have the best possible score?

What Is a Credit Score?

Your credit score indicates how creditworthy you are. There are two main reasons that credit scores are used.

First, your credit score will be used by lenders to determine whether or not they are prepared to lend you money. If your score is too low, they will reject your applications for loans, overdrafts, credit cards and other forms of borrowing.

Second, if a lender decides to approve your application your credit score will be used to determine the basis on which they will lend you money. This could mean how much they are prepared to lend to you. It could also make a difference to the interest rate that they charge.

Note that it’s not just lenders that use your credit score. Other types of organisation such as phone companies or utility companies will also use it to determine whether they are prepared to let you pay for what you’ve used at the end of the month or whether you need to put credit on your account up front.

If you have a bad credit score you might not be allowed the latest mobile phone on a contract detail and could have to put up with a pay-as-you-go phone instead. Similarly, you might have to accept a pre-payment meter for your gas and electricity supply and that could mean that you have to pay more for your energy than you would if you were paying monthly via direct debit.

Your credit score is not just used to determine whether you are creditworthy, either. Some insurance companies use credit scores as part of their underwriting process. People with a low credit score may be refused insurance or charged higher premiums than people with a higher credit score are charged. Credit scores can also be used by landlords when deciding whether to grant a tenancy.

How Is Your Credit Score Calculated?

Each organisation has its own formula to calculate credit scores although the formulas tend to be similar.

The main factor that is taken into account is your credit history. If you have paid off your debts regularly and on time, your credit score will be higher than it will if you have missed a few payments here and there.

It’s not just loans and other forms of credit that are taken into account. Whether you have paid your phone and other utility bills on time will also affect your credit score. Basically, your credit score tracks how likely it is that you will pay back any money loaned to you.

Your credit score will also take into account how much you have already borrowed. This may be compared to how much you are earning because if you owe £5,000 on a credit card it’s not a problem if you’re a high earner but might be a problem if you are only earning the minimum wage. It will also take into account how much you have borrowed compared to how much you are allowed to borrow. If owe £5,000 on a credit card with a £50,000 limit that is better than owing £5,000 on a credit card with a £5,000 limit.

The type of borrowing is another factor. If you owe £100,000 on a mortgage that will be treated differently to owing £100,000 on a credit card. But lenders like to see that you can handle different types of debt, so your credit score will be higher if you have a range of different types of borrowing rather than just having one type.

Bear in mind that your credit score is just an indication of your creditworthiness and other factors will be taken into account when an organisation is considering your application for credit. If you have a bad credit score because you missed a few payments when you were off work due to an injury or illness for instance, some organisations will overlook that if you are now back at work.

It’s also worth remembering that having a bad credit score doesn’t necessarily mean that any application you make will be rejected. A landlord may agree to a tenancy if you are prepared to pay a higher deposit of can get someone to act as a guarantor. You may be allowed a mobile phone on a contract rather than on pay-as-you-go as long as you accept a monthly spending cap on your usage.

How Can You Improve Your Credit Score?

The obvious way to improve your credit score is to pay your bills on time each month. If you miss payments or worse, end up with a CCJ, your credit score will be affected.

The less obvious way to improve your credit score is to make sure you take out some credit. Your credit score measures how likely it is that you will repay your debts. The best way to demonstrate this is to actually take out some debts and pay they back.

You don’t want to have too much debt, though. If you have numerous credit cards that you are not using these should be cancelled. Ideally, you should have a single credit card with a credit card limit that is around four times your credit card balance.

Finally, although it’s a good idea to keep an eye on how much interest you are paying from time to time and switch to a better deal if one is available, if you constantly switch credit card provider that can have an impact on your credit score. If you apply too often it makes you look like you are dependent on credit. Every time you apply for credit your application is recorded in your credit history even if you don’t accept any offer that is made, so try to limit your applications to one every three months or so.

Remember that it takes time to improve your credit score. Although you should see some improvement fairly quickly any CCJs will remain in your credit history for six years. The sooner you start, though, the sooner you will start to see improvements.

Feeling like Chandler?

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About the author

Scott Nelson

Scott Nelson is a financial services expert, with over 10 years’ experience in the industry, including 6 years in FCA regulated companies. Read more
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