Credit scores are important; they affect the kind of loans we can access in the future. But how does a credit score work? How is credit rating determined? How is credit score calculated? And can you change it? It’s time to take a deeper look at this important score that affects so much of our lives.
So, what is a credit score?
Your credit score or credit rating is a number that represents how financially trustworthy you are or how reliable you are as a borrower. There are several bands that your score can fall into.
- “Excellent” includes all scores that range between 833 to 1,200.
- “Very good” includes scores between 726 and 832.
- “Good” includes scores from 622 to 725.
- “Average” includes scores between 510 and 621.
- Any score below 510 is considered below average or even poor. But remember that a bad credit score doesn’t necessarily prevent you from getting a loan!
It is possible to get a loan if you have poor credit, but it’s a good idea to try to improve your credit first if possible, as this can mean better interest rates.
How is credit rating determined?
There are several things that factor into your credit score, but most of it comes down to your borrowing history. Any loan you’ve ever taken out will contribute to your credit score, as will how steadily you repay your loan(s). For example, even a HECS-HELP loan that you repay automatically will help you build a healthy credit score. So will paying all your bills on time.
There are a lot of ways to improve your credit score if it’s not at the level you want it to be at; a bad credit score isn’t the end of the line.
How to find out your credit score
Improving your score is one thing, but you need to know what your score is if you want to watch it improve. The Australian government website Moneysmart has some great resources and suggestions if you need to figure out what your credit score is. There are some myths around credit scores that suggest that checking your credit score will negatively affect it, but we busted that myth (and several others about credit scores) already.
What’s the purpose of credit scores?
Now that you’re no longer wondering how a credit rating works, you might still be wondering why you even need a credit score. For lenders, each time they offer a loan they are engaging in a certain amount of risk. There’s always the possibility that a borrower could default on a loan.
Higher credit scores let lenders know that a borrower is a lower risk. This can affect the interest rates you see as a borrower. If a lender notices a low credit score and is worried about losing money if they lend to that person, they may charge more interest to mitigate losses. A lower risk borrower with a higher credit score might see lower interest rates.