Credit Scores: What you should know
A good credit score can potentially save you money when it comes to interest rates, down payments and the terms on a new credit card. But how is your credit report calculated? And what actions have a negative effect on your rating? The answers might surprise you.
Veda? Who is Veda?
Veda Advantage is a privately owned company which generates the credit files for all Australians. Their scoring system works by comparing your particular credit history with the rest of the population and then rating you accordingly. Your rating is known as your VedaScore, and it is one of the many factors that a bank or lender takes into consideration when assessing your loan application.
Buying a house is a major decision. In fact, for many of us, a home is one of the biggest financial investments we will ever make. As such, it’s understandable that people tend to shop around for a good deal on their home loan, but in some cases, looking around for the best rate can actually work against you.
Each time you apply for a new line of credit, you are typically met with what is known as a Hard Enquiry. Hard Enquiries occur when a lender, company or institution checks your current credit report before making a lending decision, so, things like applying for a loan or credit card, whether it’s approved or not, will trigger a check. Each enquiry lowers your credit report by only a few points, however the record of these checks can stay with you for up to five years.
Multiple enquiries for credit cards, mortgages and personal loans can look like a series of denials to a lender and can cause them to question why you have had to submit multiple applications to their competitors. The other thing to keep in mind is that your credit file is actually created the first time that you apply for funding, so if you’ve never applied for credit, then you don’t actually have a credit file. This can be a problem in itself because without a decent credit history, lenders don’t know exactly what to think of you.
Many banks follow a conservative policy where if you have already applied for a loan with your main financial institution (MFI), then they will automatically decline your loan. This is because other lenders are unable to tell if your main bank has approved or declined your loan, and if you were declined by your own bank, then you are almost certainly a high credit risk.
The number of recent enquiries is just one piece of information that lenders look at when assessing your application, however, when multiple enquiries are coupled with other red flags, the lender can begin to see you as too risky to do business with.
Another factor is the type and frequency of your credit applications which are measured under what is known as borrower shopping patterns. For example, someone who has applied for a number of credit cards within a short period of time can be viewed as a high risk to a lender, whereas someone who has applied for a home loan years ago, and another one last month, will be seen as a low risk borrower with a good shopping pattern.
Key factors that negatively affect your credit rating:
- Not paying the minimum on a credit card each month
- If you are denied finance or credit and you continue to apply with other lenders
- Submitting multiple loan enquiries
- Court Judgements
- Paying phone or electricity bills late
When it comes to home and car loans, some lenders acknowledge that a number of enquiries racked up in a short period of time probably just means that the potential borrower is simply shopping around for a good rate, but the window of time for rate comparison is limited and varies between lenders. Lenders take all attempts to apply for funding into consideration, viewing them as an increased risk when deciding on approval for your application. This is why, unless you are confident that you know the lender’s direct policies, you risk sabotaging you chances for approval by submitting multiple applications.
If you find yourself in a situation where lenders are declining your applications because you’re viewed as a “credit junkie” due to the number of your recent applications, there are still specialist lenders who might still be interested in helping you out. Part of their process is sitting down with potential clients and going through the reasons for each application to assess their eligibility and associated risk.
If your credit score could use some improvement, there are a number of ways to help you get back on track, but before we get to that, let’s look at some of the key factors that make up a credit score:
- Employment: Generally speaking, you must not still be on probation and must have been at your job for 6-12 months.
- Savings: When applying for most loans, you must have at least 5% of the purchase cost in an account it you are looking to borrow over 80% of an assets value
- Stability: If you have held many jobs and moved around a lot over the last few years, lenders can see you as unstable which can lower your credit score
- Assets and liabilities: Your assets should make sense for age and income bracket. If you have high debt and no assets, you score will suffer
- Insolvency: If you have more debts than assets most lenders will decline you as you are technically insolvent
- Industry: If you work in an industry that is seasonal or fluctuates, for example mining or construction, or work in a casual on contract basis, then your credit rating will be lower
With these key factors in mind, we can start to identify which categories you might fall into and how to improve your overall credit score. Some factors, such as length of employment, will obviously just take time, whereas others, like the industry you work in, might not be able to be changed at all.
There are however some general tips that everyone can follow to help improve their credit rating:
- Don’t overdraw your cheque account
- Don’t go up to, or over, your credit card limit
- Pay off your credit card debts as much as possible
- Pay off your all of your debts as soon as possible (utilities, overdrafts, personal loans, etc)
- Pay off any outstanding defaults on your credit file and wait for them to be removed if you can
If you’re looking to finance a house, a car or anything else, it’s best practise to research different lenders and choose the one that is offering the best finance option for your situation, rather than applying to multiple lenders with the hope of getting an approval. On the other hand, you can use a professional finance broker to compare dozens of loan products that best suit your circumstances without accruing multiple enquiries against your credit report.