Know the Score – What you need to know about Credit Scores

Your credit score is just one of the pieces of information that lenders (and other creditors like trade suppliers or landlords) look at when considering whether to do business with you. For most people a credit score is a bit like their appendix, they’re pretty sure they’ve got one, but they’d struggle to tell you exactly what it is, and it’s never really a problem… right up to the point where it suddenly is.

Your credit score can have a significant impact on your ability to obtain any sort of debt, and as a consequence a flow-on impact in your ability to start or grow your business. In this article I’m going to try to explain a little bit about how credit scores are calculated, why they matter, and how you can keep better control of yours.

Firstly, what is a credit score? A credit score is simply a number on a scale, usually between 0 and somewhere around 1000 (depending on which company is doing the scoring). The score is just one part of a Credit Report which will also capture things like payment defaults, court actions, bankruptcies and more. Almost every lender or business that feels they’re taking credit risk on you or your business will use that score, along with other information, to decide whether you represent a good risk.

Where do credit scores come from? The overarching term is Credit Reporting Agencies, or Credit Bureaus. In practical terms across Australia and New Zealand that usually means either Equifax (formerly VEDA), Illion (formerly Dun & Bradstreet), or Centrix. These companies collect information about businesses and individuals from a variety of sources, and then charge other authorised users a fee to access that information. It’s worth noting that as an individual you generally have a right to access and correct information held about you (but they might not make it easy).

How did you get a credit score? If you’ve ever obtained any sort of credit, you’ll almost certainly have a credit score with at least one of the Credit Reporting Agencies. This could have been anything from a pay-as-you go phone, to a car loan or mortgage. The very first time this happened your file will have been created with one of the agencies. Believe it or not this is actually a good thing, because having no credit file can be seen as being just as bad as (or sometimes even worse than) having a poor credit file, particularly if you’re out of your late teens. Once you have a credit file, any new enquiries are added to it over time, building up a picture of who you borrow from, how much, and how often.

So, how is the score calculated? Scores differ between businesses and individuals, and none of the credit bureaus will tell you exactly how they calculate their particular score, but some things are fairly consistent:

General Factors – Things like your age, tenure with your current employer, and the amount of time you’ve spent at your current address can all be used as part of assessing your risk profile.

Type of credit – Some types of credit may impact scores more than others. For example, a mortgage enquiry might impact your score differently to a personal loan, and a credit card might be different again.

Number of enquiries – Often referred to as shopping patterns, the number of enquiries and the time period they occur over can impact your score. As a general rule lots of credit enquiries over a short period of a time can have a considerable negative impact on your credit score.

Defaults – This is a big one, if you’ve ever failed to pay a debt and just ignored the problem, then chances are pretty high it will eventually end up on your credit file. The size of the debt, how long ago it was, and what sort of business it was owed to, can all impact your credit score to a greater or lesser degree. The biggest impact however will come from whether the debt was eventually paid or not. Into this category I’d also add things like court writs or default judgements.

And then came Comprehensive Credit Reporting. As you might have gleaned, a significant portion of credit reporting is about things that may reduce your credit score, or what might be termed ‘black marks’ on a credit file, however that is starting to change. Although it’s been around a while (since 2012 for NZ and 2014 for Australia), Comprehensive Credit Reporting (or CCR for short) is still in its infancy. CCR allows for much more information to be collected and shared by credit bureaus, theoretically to give a more balanced view of an individual’s credit history.

With CCR information such as whether you actually obtained credit (rather than just knowing you applied for it), as well as payment history and credit limits can be shared. This is meant to give greater insights into not just how much credit you’ve applied for, or where things have gone very wrong, and instead show if you’re keeping up with all of your commitments and whether you’ve currently taken on what might be considered too much debt.

So, what can you do to protect your credit score / credit file?

The most obvious thing is to make sure you don’t default on your payment obligations. If you have run into financial trouble or a dispute it’s far better to address it before the problem hits your file. Don’t just avoid debt collectors or parties you owe money to, instead try to come to some arrangement with them. Many providers will accept a negotiated settlement for a debt and refrain from listing a default by agreement.

If you do have a default on your file it will have a far greater impact on your credit score if it remains unpaid. Again, you may be able to negotiate a settlement with the party that listed the default, most businesses would rather get some of the debt paid than none of it.

Time may not heal all wounds, but it can eventually heal most things on your credit file. If you’re thinking about starting a business next year but you still have an unpaid default on your file, pay it now. The further back in history a black mark is, the less it will count against you (everyone can change right?).

Limit your shopping around. If you’re looking for finance be careful how many places you apply with, and if you’re working with a finance broker ask them how they minimise the number of enquiries on your file. Most good finance brokers will put in the effort to match your requirements with a lender that’s more likely to approve you, which can make a big difference.

You should also take care with the types of credit you apply for or obtain. Multiple enquiries from credit card providers, short-term lenders, or pay-day lenders can all negatively impact your credit score.

If you can, pay your bills on time. With CCR it’s now more important than ever to make sure that you pay your bills on time. It might not make a big difference if you drag out the bill for last Thursday’s morning tea with the café downstairs, but for things like loans and utilities you can expect they will soon be reporting your ‘Average Late Payment Days’ if they’re not already.

Whilst the scores differ somewhat between them, it’s fair to say that a score below 300 is going to be a significant impediment to obtaining most credit. 300 to 500 will be seen as poor or below average and may make some credit difficult or more expensive. 500 to 700 you’re middle of the road. And up above 700 you’re going to be considered a fairly safe bet.

If you’d like to check your own credit score, you can visit the websites for Equifax, Illion, or Centrix; generally these providers will provide individuals with their own personal credit reports free of charge. And if you do find a mistake impacting your credit file make sure you get it cleared up asap! You never know when you’ll need your credit score, but you definitely want it to be at its best when you do.

– Phil Chaplin, CEO