Why Credit Scores Can Mislead
With the rise of on-line credit monitoring services such as Equifax or Experian many people are aware of what their credit score is.
A client recently came to me as he had held off applying for business finance until his credit score had exceeded 900 as this would give him easier access to lending. Fair enough, it was the inference given by the credit rating system he was using and adverts about borrowing often talk about your credit score.
What most people don’t understand is that their credit score is largely irrelevant and counts for little when applying for finance. Here’s why.
How Credit Scores Are Generated
Most credit reference agencies use a series of indicators and algorithms to generate an actual ‘figure’. In the UK lenders will all take the same information and generate their own result, all using a different set of indicators and a different algorithm.
Lenders do this so they can move the ‘pass mark’ in line with how keen they are to take on borrowing or where they may have seen defaults recently. Different lenders have different levels of acceptable risk and as such a different pass mark.
The main factors that influence your credit score are;
- Payment performance, have you paid things on time
- CCJs, defaults and dormant borrowing
- How much you have borrowed compared to the total lending available to you
- Whether you have any borrowing at all
This gives you the ‘credit score’. OK, there are many more factors but these are generally the big hitters.
Lenders do something very different.
What The Lender Does
For most lenders your credit history is the most important thing. The credit score you see is generally built around the last 12 months experience they have on you, it is a fairly short term thing.
Most high street lenders will look back 6 years. This means they will look at your credit history over a much longer period. What this means is that whilst your credit score may look great, those few missed payments or mobile phone dispute 4 years back could prevent you from borrowing.
All lenders will loom at your history over a different period. Generally the higher cost lenders will look back over a shorter period or accept more anomalies in your credit history.
This is where you think your credit score is looking great and suddenly you get declined. Your credit score is a short term thing whereas lenders ignore your score and look at your history.
What To Do
Rather than look at your credit score and think things are going well, start digging into your history and put things right. Some good practice here is;
- Understand the terminology and icons used on your credit history. Read the guide
- Look at your history and check that everything has been paid and is showing as having been paid
- Where anything looks wrong then take it up with the company in question. If you find this difficult or the company is being resistant to helping then send off an Freedom of Information letter to them asking for copies of everything
By all means keep an eye on your score as it will act as an early warning of something being wrong, just don’t think a lender is looking at the same thing as you.
By Dave Farmer
Lime Consultancy provide business finance solutions to commercial entities across the UK. Personal credit standing impacts on the price and availability of commercial finance. For any questions about this post please add them above or contact us direct.