Another in a series arimed at helping sellers get their lives back on track as the economy slowly improves.
How To Build Your Credit Rating
by Chrissy Hoey
The creditworthiness of an individual is determined by a number of factors, including age, address, employment status and income. These factors combine to form a numerical score of each individual, but to establish a person’s creditworthiness in full requires a deeper analysis of their financial affairs.
Lenders examine various other factors to calculate the risk of lending to an individual. The greater the risk, the lower the score. People with an excellent credit rating, therefore, tend to be considered low-risk borrowers, but creditors also place value in known quantities, which is why young people who have never before secured credit sometimes have lower credit scores than those who have encountered debt problems in the past.
Regardless of whether a person has a chequered credit history or no credit history at all, building a credit rating from the bottom requires a considerable amount of time, patience and planning.
No credit history
School and college leavers might struggle to open a bank account in today’s economy, let alone find abundant sources of available credit. Lenders have had to tighten their lending criteria following the credit crunch of 2008, so obtaining loans, mortgages and credit cards is no longer easy. Assuming that a young person is able to open a bank account, they will normally be required to spend several months in employment before they qualify for basic credit services, such as an overdraft. Student accounts are somewhat different, not least because banks gamble on students’ ability to repay loans and overdrafts on graduation.
To build a credit history from scratch, an individual should demonstrate an ability to manage their finances in a way that might be considered sensible and responsible. If possible, the individual should save a large proportion of their weekly or monthly earnings. Adopting self-discipline and financial responsibility at an early age can produce dividends later in life. Crucially, this can also encourage lenders to offer credit to those whose creditworthiness has yet to be established.
Obtaining a high-interest, low-limit credit card can be useful if the borrower always makes repayments on time. One strategy for building a credit rating is to make several purchases on the credit card, paying off the balance in several monthly instalments. After a short period, the individual’s credit rating will begin to improve.
Purchasing a mobile phone on contract can achieve the same result. Provided that monthly payments are affordable, the contract should produce further evidence of an individual’s ability to honour a credit agreement. Eventually, an individual will be able to add other credit services to their profile, to further improve their credit rating. Store accounts, loans and hire-purchase agreements can all help to build a good credit profile; if repayments are made on time without exception (even one late payment can stall the progress of a person’s credit rating for several months).
Active credit accounts are considered more valuable than closed accounts (at least to the majority of credit reference agencies), but too many active accounts or too much personal or household debt can further limit an individual’s creditworthiness. The aim of building a credit profile from scratch is to obtain less desirable credit (assuming the applicant has average wealth and income) in the short term, clear all debts early and then apply for credit on better interest terms. Debt should not be allowed to swell during this process.
Poor credit history
As noted above, a person who has experienced debt problems in the past may start from the same position as a person who has no credit history at all. Much depends on the circumstances. If, for example, a person has outstanding defaults or is currently bankrupt, they cannot expect their credit rating to improve in the near future and they will be treated less favourably by lenders, than a young person applying for their first loan or credit card.
People who have a history of debt problems must tackle any outstanding arrears as a matter of urgency. Negotiating repayment terms with creditors is a step in the right direction, so a debt management plan or consolidation loan should be considered, to ensure that the situation does not worsen. History of bad debt can stay on a credit profile for numerous years, so patience is required. Eventually, a credit rating can be improved.
Chrissy Hoey is with Baines and Ernst, a credit management company in the UK.