There are only a few pieces of financial advice that you should always carry with you; save for the future, settle your debt as quick as possible, live within your means and always have a great credit score.
Having a great credit score is one of the most important achievements that will benefit you financially. And most people, unfortunately, don’t know the important a credit score really is. Your credit score has the potential to shape everything when you apply for credit. From the interest rates to the amount of credit you can get. It can even mean the difference between an approval or not.
This score is important because it tells lenders how reliable you are in paying back the money you’ve borrowed.
If you are a high risk to lenders, you will be charged more for borrowing money. But if lenders can tell that you are responsible with your debt, you will be offered a much better deal. And ultimately, you’ll be saving a lot more along the way.
The bottom line – a credit score shows creditors how risky you are as a customer.
Let’s have a closer look at what exactly a credit score is and why it’s so important.
What is a credit score?
A credit score is a three-digit number that represents your likelihood of paying back debt. Banks and lenders use this score to approve your credit card or loan application. Credit bureaus calculate your credit scores providing lenders with a number. The higher this number, the better your credit score.
Bureaus and banks use various methods when calculating credit scores. The method may change depending on the type of credit or the bureau. However, regardless of the method being used, all credit scores function the same way.
Credit score breakdown
It reflects how you manage your personal finances.
When you apply for a loan, lenders will do a background check on you to see how reliable you are. They will accept or decline your loan application according to the background check.
Lenders will see someone with a bad credit score as high risk. If lenders decide to accept your application, and you’re a high-risk client, they will charge you a higher interest rate than someone with a good credit score. That means you’ll be paying more in the long run, than someone who gets offered a lower interest rate.
In some cases, like banking, companies do a background check on potential employees. They check credit reports and scores to evaluate whether you would be a trustworthy employee. And occasionally, even landlords do their background checks on potential tenants.
It is a good idea to investigate your own credit score before applying for a loan. You are, as a South African, allowed to one free copy of your credit record every year.
Calculating credit scores
There are four major credit bureaus, each with their own scoring model. And not all lenders share the same bureau. So checking your credit score beforehand might benefit you when trying to get a better deal on that next loan application.
Although bureaus use different scoring models, they all have to use the same information. This information includes:
- Your payment history
- For how long you have had credit for
- The types of credit you have (student loan, credit card, car loan, mortgage etc.)
- What are your credit limits and how much of this are you using
Building a credit score?
If you’re young, you probably don’t have a lot of debt. Maybe a student loan, but nothing too hectic. Staying away from debt is always the better option. But how do you go about building your credit score if you don’t have debt?
You will have to start making healthy debt so that the credit bureau has enough data to collect and provide you with a score. You can do this through:
- Credit card
- Phone contact
- Store account
- Vehicle finance
Keep in mind that debt can be dangerous. It is a luxury that we should all stay away from. So when making these small loans be aware of why you have them. They’re not there to make you feel good on a rainy day. You’re opening these accounts so that you can get better rates on your first mortgage or car loan.
What affects your credit score?
Once you actively start using your accounts with banks, retailers or lender, you’ll start building your financial history. Your credit history will show how much money you’ve borrowed in your lifetime and how much of that money you’ve paid back on time and in full.
Your payment history plays an important part in the outcome of your credit score. How loyal you are in making your payments on time will dramatically affect your score. Some have argued that this is the biggest factor when calculating credit scores. Paying on time and paying just a bit more than what you should will have a positive effect on your score.
The relationship between your credit limit and how much of your balance you’re using also affects your score. Using your credit card too much will negatively affect your score. This will show banks that you are not managing your finances reasonably. A general rule of thumb is to only use 30% of your credit limit. That’s your safe zone. It tells the lenders that you’re using your credit card responsibly, especially if you pay it all off as quick as possible.
Having a credit history shows that you have experience in dealing with debt, making you a more reliable client to lenders. However, opening and closing several accounts at once will negatively affect your score. Rather open or close accounts as you need them.
The type of credit you have will affect your score as well. There are two types of credit; revolving accounts and instalment loans. Having both types of accounts will positively affect your credit report. This shows lenders that you are experienced with managing various types of credit. Taking out loans for different types of assets will also be in your favour. This would include taking out a car or a home loan if you can, in addition to your credit card or store card accounts.
Benefits of having a good credit score
A good credit score generally means that you will be offered better rates for a credit application. Lower rates can save you a lot of money along the way. Getting these benefits boils down to how responsible you are with your debt.
Having a good credit score will help you negotiate better deals with lenders. You will end up paying less and saving more, only because you have a good credit score.
Let’s assume there are two people applying for the same mortgage which they’ll pay off over twenty years, and the only difference being their credit scores. How would their credit score affect their interest rate? And what would the difference be in their monthly repayments over 20 years?
**The FNB Bond Calculator was used to do the calculations in the graph above. You can find it here.
How can you get your credit score?
Here are three major credit bureaus that will provide you with your credit score.
No matter the outcome of your score, it is never too late to improve. The difference between a good credit score and a bad one could stand in the way between you, and your dream home.
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