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What a Credit Score Is and How It Affects Borrowing

Your credit score plays a crucial role in determining your access to affordable borrowing options. As we navigate through 2024, understanding what a credit score is and how it impacts your ability to secure loans and credit has never been more important. With the UK economy still recovering from the challenges of recent years, lenders are increasingly relying on credit scores to assess the risk of lending to individual borrowers.

A credit score is essentially a numerical representation of your creditworthiness, reflecting how likely you are to repay debts on time based on your past financial behaviour. The higher your score, the more favourably lenders will view you as a potential borrower, opening up access to better interest rates and loan terms. Conversely, a low credit score can make borrowing more difficult and expensive, limiting your financial options.

In this comprehensive guide, we’ll delve into the intricacies of credit scores, exploring what factors influence them, what is considered a good score in 2024, and crucially, how your credit score can impact the cost of borrowing. We’ll also provide expert tips on how to improve your credit score this year, empowering you to take control of your financial future. Whether you’re planning to apply for a mortgage, car finance, or simply want to ensure you have access to affordable credit when you need it, understanding the role of your credit score is essential.

Section 2: What is a Credit Score?

A credit score is a three-digit number that represents your creditworthiness, or how likely you are to repay debts on time. In the UK, the three main credit reference agencies (CRAs) – Experian, Equifax, and TransUnion – each have their own scoring system, with ranges varying between them.

Experian scores range from 0-999, with 721-880 considered fair, 881-960 good, and 961-999 excellent. Equifax scores range from 0-700, with 380-419 considered fair, 420-465 good, and 466-700 excellent. TransUnion scores range from 0-710, with 566-603 considered fair, 604-627 good, and 628-710 excellent.

Your credit score is calculated using information from your credit report, which is a record of your borrowing and repayment history. The main factors that make up your credit score include:

  • Payment history (35%): Consistently paying bills on time demonstrates financial responsibility and boosts your score.
  • Credit utilisation (30%): This is the amount of available credit you’re using. Keeping your credit card balances below 30% of your credit limits is ideal.
  • Length of credit history (15%): A longer history of responsibly managing credit generally leads to a higher score.
  • Credit mix (10%): Having a diverse mix of credit types (e.g., credit cards, loans, mortgages) can positively impact your score.
  • New credit inquiries (10%): Applying for multiple new credit accounts in a short period may temporarily lower your score.

It’s important to regularly check your credit report for errors that could negatively impact your score. You can take action to raise and sustain your credit score by being aware of the elements that affect it. This will help you get favourable borrowing terms in 2024.

Section 3: What is Considered a Good Credit Score in the UK?

In the UK, credit scores typically range from 0 to 999, depending on the credit reference agency (CRA). The three main CRAs – Experian, Equifax, and TransUnion – each have their own scoring system and ranges for what constitutes a “good” credit score in 2024.

According to Experian, a good credit score falls between 881 and 960 (out of 999). Equifax considers a credit score between 420 and 465 (out of 700) to be good, while TransUnion defines a good credit score as falling between 604 and 627 (out of 710).

It’s important to note that while having a credit score within these ranges is generally considered good, it doesn’t guarantee approval for credit or the best interest rates. Lenders may have their own criteria for assessing creditworthiness, which can vary depending on the type of credit product and the individual lender’s risk appetite.

Moreover, the average credit score in the UK has increased slightly from 2022 to 20232, possibly due to changes in consumer financial behaviour during the COVID-19 pandemic. As of 2023, the average credit score in the UK is 759 for Experian, 380 for Equifax, and 610 for TransUnion.

Achieving a good credit score can significantly improve your chances of being approved for credit at favourable terms. Borrowers with higher credit scores are generally seen as lower risk by lenders, which can translate into lower interest rates, higher credit limits, and better loan terms.

To maintain or improve your credit score, it’s crucial to consistently demonstrate responsible financial behaviour, such as making payments on time, keeping credit utilisation low, and limiting applications for new credit.

Section 4: How Do Lenders Use Credit Scores?

Lenders rely heavily on credit scores when assessing loan applications to determine the risk associated with lending to a particular borrower. When you apply for credit, whether it’s a mortgage, personal loan, or credit card, the lender will check your credit score as part of their decision-making process.

A good credit score can work in your favour, as it demonstrates to lenders that you are a responsible borrower who is likely to repay debts on time. Consequently, those with higher credit scores are more likely to be approved for credit at the most competitive interest rates and favourable terms. Conversely, a low credit score may result in higher interest rates or even denial of credit altogether, as lenders view these applicants as higher risk.

It’s important to note that many lenders have tightened their lending criteria in 2023-24 due to economic uncertainty. This means that they may be more cautious about extending credit, even to those with good credit scores. Lenders are increasingly turning to machine learning and alternative data sources to gain a more comprehensive understanding of a borrower’s creditworthiness.

In addition to credit scores, lenders also consider other factors when making lending decisions, such as:

  • Income: Lenders want to ensure that you have a stable income sufficient to cover your loan repayments.
  • Debt-to-income ratio: This measures how much of your monthly income goes towards debt repayments. A high ratio may indicate that you are overextended and less likely to be able to take on additional debt.
  • Collateral: For secured loans like mortgages, lenders will consider the value of the asset (such as a house) that you are offering as collateral for the loan.

It’s clear that credit scores remain a critical tool for lenders in assessing borrower risk. However, the rise of open banking and alternative data sources is enabling lenders to take a more nuanced approach to credit decisioning. You can take action to make yourself appear like a desirable borrower and increase your access to credit at reasonable rates by being aware of how lenders utilise credit scores and other criteria to determine loan decisions.

Section 5: How Credit Scores Affect the Cost of Borrowing

Your credit score has a significant impact on the cost of borrowing in the UK. Lenders use credit scores to assess the risk of lending to you and to determine the interest rates they’ll offer. Generally, the higher your credit score, the lower the interest rate you’ll be offered, as you’re seen as a lower-risk borrower.

To illustrate the impact of credit scores on borrowing costs, let’s consider a £200,000 mortgage with a 25-year term. According to data from Experian, one of the UK’s main credit reference agencies, a borrower with an excellent credit score (961-999) could secure an interest rate of around 1.2% on a two-year fixed-rate mortgage as of March 2024. This would result in monthly repayments of approximately £764 and a total interest payable over the 25-year term of £29,200.

In contrast, a borrower with a fair credit score (721-880) might be offered an interest rate of 2.5% on the same mortgage. This would lead to monthly repayments of around £897 and a total interest payable of £69,100 over the 25-year term – more than double the amount paid by the borrower with an excellent credit score.

The difference becomes even more stark for those with lower credit scores. A borrower with a poor credit score (561-720) could face an interest rate of 4.5% or higher, resulting in monthly repayments of £1,111 and a total interest payable of £133,300 over the 25-year term.

It’s important to note that these figures are illustrative and that actual interest rates will vary depending on the lender, the borrower’s individual circumstances, and prevailing market conditions. Nonetheless, they demonstrate the significant impact that credit scores can have on the cost of borrowing.

The same principle applies to other forms of credit, such as personal loans, car finance, and credit cards. Those with higher credit scores will generally be offered lower interest rates and more favourable terms, while those with lower scores may face higher costs or struggle to access credit at all.

In the current economic climate, with the Bank of England base rate at 5.25% as of March 2024, borrowing costs are higher than they have been in recent years. This makes it more important than ever for borrowers to understand their credit scores and take steps to improve them where possible.

You can gradually raise your credit score by monitoring your credit report on a regular basis, fixing any mistakes, and establishing a good credit history. This, in turn, can help you access more affordable borrowing options and reduce the overall cost of credit.

Section 6: Steps to Improve Your Credit Score in 2024

Improving your credit score is a crucial step towards securing favourable borrowing terms in 2024. While there’s no quick fix, consistently demonstrating responsible financial behaviour can help you boost your credit score over time. Here are some actionable steps you can take to improve your credit health this year:

  • Check your credit report regularly and dispute any errors:
      • Request a free copy of your credit report from each of the three main UK credit reference agencies (Experian, Equifax, and TransUnion) and review them carefully for inaccuracies.
      • If you spot any mistakes, such as incorrect personal information or misreported account details, contact the relevant credit reference agency to file a dispute and have the errors corrected.
  • Register on the electoral roll:
      • Signing up to vote can provide a quick boost to your credit score, as it helps lenders verify your identity and address.
      • Make sure to update your electoral roll information promptly if you move to a new address.
  • Pay your bills on time:
      • Consistently making on-time payments is one of the most significant factors in determining your credit score
      • Consider setting up direct debits or standing orders to ensure you never miss a payment deadline
  • Keep your credit utilisation low:
      • Aim to use no more than 30% of your available credit limit on each credit card and across all your cards combined
      • Paying down existing balances and resisting the urge to make new purchases can help keep your credit utilisation ratio low
  • Avoid applying for new credit too frequently:
      • Each time you apply for credit, a hard inquiry is recorded on your credit report, which can temporarily lower your score
      • Space out your credit applications and only apply for new credit when absolutely necessary
  • Consider using a credit-builder tool:
      • Tools like Loqbox and Experian Boost can help you build a positive payment history without taking on additional debt
      • These services report your regular payments for things like rent, council tax, and Netflix to the credit reference agencies, which can help improve your score over time
  • Seek professional advice if needed:
    • If you’re struggling with debt or have a history of missed payments, consider seeking guidance from a reputable credit counselling service
    • Organisations like Advice Debt offer free, impartial advice on managing your finances and improving your credit standing

Remember, improving your credit score is a gradual process that requires patience and persistence. Over time, by following these guidelines consistently, you can raise your credit score and get approved for better loans.

Section 7: Conclusion

It is essential to comprehend your credit score and how it affects your ability to borrow money. Lenders are depending more and more on credit scores to determine the risk of making loans to specific borrowers as we negotiate the post-pandemic economic environment. A higher credit score can unlock access to more favourable interest rates, loan terms, and credit limits, ultimately saving you money in the long run.

However, achieving and maintaining a good credit score requires consistent financial responsibility and a proactive approach to managing your credit. By regularly checking your credit report, correcting errors, paying bills on time, keeping credit utilisation low, and demonstrating stability in your living and employment situations, you can work towards improving your credit score over time.

As we look ahead, the rise of Open Banking and alternative data sources is poised to revolutionise the credit landscape, enabling lenders to take a more nuanced approach to assessing creditworthiness. Through adoption of these innovations and proactive measures to establish a favourable credit record, you can set yourself up for success in the changing lending landscape of 2024 and beyond.

Remember, your credit score is not a fixed entity; it is a dynamic reflection of your financial behaviour. With patience, persistence, and a commitment to responsible credit management, you can take control of your financial future and unlock the doors to better borrowing opportunities. If you find yourself struggling with debt or in need of guidance, organisations like Advice Debt are here to provide free, impartial advice and support on your journey to financial wellbeing.

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