What is a Credit Score?

How Does the Credit Scoring System Work & What is it Used For?

Sep 28, 2009
Carol Finch

What Is A Credit Score? - Image by iprole

Those applying for a loan/new financial account may not get approval until the lender has estimated their credit score. What is the scoring based on & what does it mean?

Most lenders will take some time to approve an application for a loan or a financial product. They need to make sure that they are lending money or giving credit to those people most likely to pay them back. To work this out they access the individual's credit record and use it to build a score. This tells them how much of a risk it will be to deal with the individual. What is a credit score?

How Does a Credit Score Range Affect Lending Approval?

Any decisions made by lenders on approval or interest rates may well depend on how good or bad an individual's credit score works out to be. A high credit score equals lower risk to lenders. Consumers in this position will have no problems raising credit and will attract the best rates of interest. A lower score, on the other hand, could lead to rejected applications or to higher charges.

How do Lenders Work out a Credit Score?

This process involves a lender looking at an individual's credit rating to see what is on there from both a positive and negative viewpoint. Problems that may be listed on the record will lower the potential score. Good financial management and responsible behaviour will increase it.

Although some countries are relatively open about how credit scores are assessed, it can be hard to pin down exactly how this works in the UK. Lenders can use a variety of scoring methods and systems and they don't tend to advertise the way that they make their calculations. Also, each lender may grade at different levels. So, where one lender may reject an application at a certain level, the next may approve it.

In general terms, however, lenders usually look for the following issues when they score an individual:

How long the individual has had financial accounts listed on their record and how many accounts they currently have on the go.
Examples of previous financial difficulties (i.e. missed and/or late payments).
Evidence of significant debt problems (i.e. defaults, CCJs, IVAs and bankruptcies).
A healthy debt/credit limit ratio (i.e. how much the individual is in debt and how much of their credit limits are remaining).
How much new application activity is listed on the record (i.e. how many new accounts have been opened or applications made for new financial products/accounts in the last few months).

Although there is no 100% accurate way of knowing the score any lender will give, it is thought that most will look favourably on those that manage their finances well and keep well within credit limits. Many will mark down those that have had issues or look like they may have them in the future. Some will reject applications from people deemed as having no credit, even if they have had no money problems in the past.

How can Consumers Check and Repair a Credit Score?

Those thinking about applying for a financial product or those that have been turned down/offered higher than average interest rates may want to:

Check their credit record to spot potential hot spots: The major credit agencies (Experian, Equifax and Callcredit) offer free online trials that allow individuals to take a look at their credit record. It is also possible to pay a small fee to have a record sent out.
Get an estimated credit score: Most of the credit agencies and some financial websites will allow consumers to see an estimate of their own credit score. Whilst this cannot replicate a lender's process exactly, it may still give a useful idea of where they stand.
Ask the lender why they were refused credit. This could be a useful indicator of where the problem lies. Plus, in some cases, it may be possible to turn a rejection into approval.

If there are signs that their record may throw up a negative credit score then consumers could spend some time cleaning it up or improving it. If, for example, a check shows that there are errors or negative areas, then the individual may want to improve their credit record before they make another application. Using companies that claim to repair credit may not, however, be as effective as a DIY approach.

Source: Moneymadeclear. Accessed online 28th September 2009.