Understanding credit scores
What is a credit score?
A credit score is a number that identifies how worthy of receiving credit a person or business is. A creditworthy organisation or individual is a good candidate for doing business with or receiving a loan because they are reliable and have a history of repaying money on time. The higher the credit score, the lower the lender’s risk.
Why is a credit score important?
A credit score is important because it enables lenders and businesses to make informed decisions about how and to whom they extend credit. This reduces the lenders own exposure to risk because it makes it less likely they’ll offer credit to the wrong candidates. It also means they can better decide how much credit to offer.
Offering credit to an uncreditworthy individual or organisation can result in the borrower being unable to repay the loan. If this happens, the loan may need to be written off as bad debt, causing a loss for the lender.
A credit score helps determine whether an organisation or individual is a good candidate to receive credit. It also helps to ascertain how much credit they should receive, depending on their credit score. Some lenders still loan credit to those with a low credit score, but they’ll put in place stricter repayment terms to reduce their risk.
Are there different types of credit score?
Yes, there are. For example, there are personal credit scores and commercial credit scores. Personal credit scores are for individuals – this credit score determines how eligible they are for a loan, mortgage, credit card, utilities account, insurance or store card.
A commercial credit score is for businesses. A business will need a credit score if it is seeking a loan, mortgage or credit card from a bank. It may also need a commercial credit score if it’s seeking to do business with other companies – particularly if applying for trade credit. A commercial credit score lets the lender know how financially stable and reliable the applicant is – helping the lender decide whether to trade together.
How are personal credit scores decided?
All credit scores are decided through a credit report. This helps the lender determine who to lend to, as well as the rate of interest and credit limit. Credit reports differ depending on whether they are for a person or business.
A personal credit report uses the UK electoral roll to confirm the applicant’s identity and residence details. It then draws on information such as financial stability, repayment history, court records (to check if any legal action has been taken against the applicant) and credit links (if the applicant has a joint bank account or utility bills with anyone else). If they do have credit links, the other account holder’s credit history can also be taken into account.
Other factors are also considered, such as how many credit reference checks have been carried out against the applicant. In some cases, credit management data provided by other lenders and organisations can create a full picture of an individual’s credit health across credit cards, store cards, mortgages, loans, utilities contracts and bank accounts. This data may range from whether they’ve defaulted on payments to the amount they repay on debt each month. All of this information is collated and analysed to develop a credit report and, from that, a credit score is created.
How are commercial credit scores decided?
Commercial credit scores are also determined via a credit report, which collates information such as credit obligations, repayment history (both to lenders and suppliers), legal filings, judgements and bankruptcies. It also evaluates the length of time a business has operated, its size and nature, as well as its revenue, profits, assets and liabilities.
Each credit rating organisation has a different reporting and scoring system. Graydon’s reporting system includes: credit opinion scores, which are primarily based on bi-annual balance sheets; payment scores, which assesses how reliable a business in repaying suppliers; and multi scores, which evaluate a company’s mid-term opportunities and risks.
Are credit scores the same around the world?
No, different countries and regions use different scoring systems and have different credit bureaus. They also weigh factors differently when determining creditworthiness.
For example, in Malaysia, Hong Kong and Singapore, credit reporting systems are more advanced due to better technology and database systems. Consumer credit reporting is also combined with commercial credit reporting there, which is a particular advantage to SMEs seeking credit.
Can a credit score be changed?
Unless there is a factual inaccuracy in your credit report, your credit score cannot be changed without altering your credit behaviour. You can however, improve your credit score over time. For a personal credit score, simple steps like getting on the electoral role, making controlled spending on a credit card and setting up direct debits to repay credit can all help improve your credit score. If you don’t have a credit history, it’s important to build one up in order to access further credit.
To improve a commercial credit score, you can take steps such as making sure your suppliers are reporting your payments, which will help build a positive credit history. It’s also important to ensure you make repayments on time, and don’t use all of your available credit. Monitor your information carefully and check for any mistakes, keep your company filings up to date and make sure to meet Companies House deadlines. If you’re a small business, it may be necessary to keep your personal finances in order too, as lenders may look at your personal credit history.
If there’s an error on your credit report, you can dispute it. While it’s being investigated you can have a note added to your credit report to highlight that the information is being questioned. You can also add a notice of correction, to register your comments.