A Guide to Borrowing with a poor credit history
Applying for credit can be something of a minefield. This guide is designed to help you easily understand how your credit rating works, how it can be damaged and what to do if you need to boost your credit rating.
What is a credit score?
When a lender gets your application for a loan or other credit product they approach at least one of the three UK credit reference agencies – Equifax, Experian or Callcredit – to assess your credit file. These credit reference agencies hold data for every UK borrower which is gathered from electoral roll information, court records, address details and account data.
Your credit file consists of any credit application you have made from your current or previous addresses, any history of debt including County Court Judgements (CCJs) IVAs or bankruptcies and your management of bank and building society accounts as well as behaviour with credit and store cards, loans and mortgages. Your credit score is based on your borrowing and repayment history and not only determines whether your loan application will be accepted but also the rate you’ll be offered.
If you understand how your credit rating works then you are more likely to be offered the best rates, be accepted for a wider range of products and avoid the cost of unnecessary add-ons.
Your credit footprint
Every credit application you make leaves a footprint. It is this footprint that lenders use to build up a picture of borrowers. When you have credit you are also leaving a footprint based on your repayments. If you miss a loan or credit card payment then this suggests you are unable to manage your finances and has a detrimental impact on your credit score. History of bankruptcy, IVA or CCJs will also damage your credit rating. While it is advisable to pay your credit off in full each month, a good safeguard is to set up a direct debit to cover more than the minimum monthly repayment That way, you’ll never miss a payment because you’re away or you forget it is due. Missed payments can incur extra charges or even result in you being turned down for future credit so while the advice is to repay in full, it doesn’t hurt to have a contingency plan.
How your credit rating works
People panic about ending up on a credit ‘blacklist’ but it’s a myth. There is no such thing as a ‘universal’ credit rating and no ‘blacklist’ of people banned from obtaining credit. That’s good news for borrowers with a bad credit history.
Different lenders use different criteria to decide whether to lend, building up a picture of individual borrowers based on the information they have. So it’s not just your credit file that matters but also any history you have with the lender as well as the information you provide on your credit application.
Every lender scores you differently. If you have had a lot of credit but have reliably met all your repayments you will be a more attractive proposition to lenders than someone with no previous borrowing at all.
Understanding credit score risk
If you understand the concept of risk then you’ll understand how it affects your credit score. Credit scoring works by trying to predict how each borrower will behave in the future. Basically, lenders want to be sure you are worth the ‘risk’ before they lend to you and will work out your level of risk based on your borrowing history. If you have little or no credit history then they have nothing to base their predictions on.
There are companies who specialise in lending to those with poor credit but beware at what price. Rates are likely to be high and you should only borrow if you can realistically afford the repayments.
Don’t be desperate!
Every time you make an application for a credit product it goes onto your credit file for a year. Therefore, it’s sensible to plan ahead and prioritise credit rather than rushing into yet another credit application. Too many credit applications submitted over a short period of time can result in rejection as it appears you’re desperate for credit! Make sure that all-important mortgage application doesn’t get turned down because you’ve made one too many credit card or mobile phone contract application.
So, you’ve got the perfect credit score yet your application has still been rejected. Why? Credit scoring doesn’t simply categorise borrowers as good or bad risk; it also seeks out profitable customers. You may feel you are a lower risk borrower than the person who only makes the minimum repayment on their credit card each month, because you always repay in full. Actually the borrower making a reliable monthly minimum repayment can be a more attractive proposition because they will be accruing interest which is profitable whilst credit card companies will sometimes reject those who repay in full.
After being rejected for credit you can approach the lender to ask them why your application was turned down but you’ll usually be told it was because you didn’t meet their credit scoring or lending criteria. Don’t be disheartened; every lender has a different scoring system so it doesn’t mean your next application with another lender will automatically be rejected. Just be wary of making too many applications too close together as this in itself can lead to rejection.
We’ve all got history. Or have we…
It’s not just a poor credit history that can count against you. Many people are surprised to discover that having no credit history also proves problematic. They assume this makes them a safe bet, but actually potential lenders can be wary of borrowers with no history because they have no information to base a credit risk assessment on. When you make a borrowing application you leave a footprint but if you haven’t borrowed before there is no credit footprint. This places would-be borrowers in a chicken and egg type predicament – how do you build a credit history if no one will lend to you in the first place? Read on…
In need of a credit rating boost?
There are things you can do to build up a good credit rating. It is a good habit to get into to check your credit file on an annual basis and you should certainly check your credit file before making an application. Your credit file is the document that lenders refer to when they assess your suitability for a loan or other credit product. You can obtain your credit report from one of the three credit reference agencies – Equifax, Experian, Callcredit or Noodle. Sometimes you can get a free 30-day trial which allows you the time to check your credit report without paying for a subscription. Just remember to cancel it before the free period ends!
Another tip is to make sure you are registered on the electoral roll at your home address, and that your credit reference file is up to date. Keep your applications down to a minimum, as lenders will be cautious of those who have previously been refused credit.
There are credit rebuilds cards available on the market for those with a poor credit history. They usually have an extortionate rate of interest so you need to be really careful but if you have no credit history and use the card to pay for your usual monthly purchases then you can build a rating. You MUST remember to repay in full each month so you don’t fall prey to the high interest rates.
Why your credit rating matters
If previous financial mismanagement has left you with a poor credit rating then it may be prove difficult to obtain credit in the future which could have an impact on all kinds of big financial choices such as getting a mortgage. Sometimes lenders will offer you a different product to the one you’ve applied for or less preferential rates and borrowing terms because your credit score isn’t as good as they need it to be to approve your initial loan or credit application.
It’s really important to take the time to manage your credit score and take the necessary steps to boost your rating. It’s not simply the difference between being accepted or rejected for a credit card or loan, but can also affect your car insurance, mobile phone contract, bank accounts and more. Don’t let a poor credit rating come back to haunt you just as everything in life is falling into place.