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Category: Credit Scoring

What Is an Individual’s Credit Score and How Is It Calculated?

Regardless of what bank or credit card company an individual chooses to use, he will have to pass an evaluation process to gain access to their financial services. During this process, lenders look at his financial history and his credit file. They use the information extracted from these two sources, along with his credit score when deciding both the eligibility for various forms of financing as well as other details such as the borrowing limit and the interest rate that are attached to loans and credit cards.

Of these elements, the credit score is often the most mysterious, mostly because borrowers are usually unaware of what it is and how it is calculated. Furthermore, lenders do not usually disclose details related to their assessment process. Unfortunately, there is no simple way of explaining what a credit score is as its value is determined by multiple factors, each of which weighs differently, depending on the credit reference agency that calculates it.

This having been said, it is possible to look at what values go into calculating this number. Here is what you need to know:

What Is A Credit Rating?

An individual’s credit score is a figure that is calculated by looking at his long-term financial habits and status. These values are not calculated by lenders, but by specialised agencies that focus on keeping financial records on individuals throughout the country. These are called “credit reference agencies”, or CRAs.

There are currently 3 consumer CRAs that operate in the United Kingdom:

  • Equifax;
  • Experian;
  • TransUnion;

Each of these has a different formula that is used to calculate a consumer’s credit rating and none of them has disclosed it to the public.

Generally speaking, credit scores are used by a wide variety of lenders, including banks and some local credit unions. These values cannot be changed overnight and are based on an individual’s financial history. In other words, missing a monthly payment will not cause irreparable damage to your credit rating, but a lifetime of poorly managed debt may be extremely difficult to make up of.

How Are Credit Ratings Calculated?

While there is little clear information regarding what formulas CRAs use to calculate credit scores, analysts have disclosed that the following factors are important:

  • Credit Utilisation Ratio – An individual’s credit utilisation ratio plays a big part in calculating his credit score. This ratio shows how much money an individual borrows from what is available to him through his credit cards.
  • Available Credit – Having too much credit available to an individual will reduce his credit score. For example, having an unused line of credit or credit cards that have large limits. Generally speaking, lenders consider that his unused credit represents money that is stuck in the loan agreement and does not benefit the lender or the borrower.
  • Number of Loan Applications Submitted – Submitting a large number of loans in a short period will reduce an individual’s credit score. This includes situations where borrowers would submit applications to multiple lenders. Ideally, these should be evenly spaced out over a greater period of time.
  • Repayment Consistency – How a borrower repays his debt plays a big part in the value of his credit score. Keep in mind that this score is built over time, which means that missing a payment will not cause serious damage. However, missing or delaying payments every month will have a big impact on your credit score.
  • Utility Bills Payments – Almost all electricity and gas companies submit their financial data to CRAs, including the payment habits of their clients.
  • County Court Judgements – County Court Judgements are court orders registered against individuals who fail to repay their debts. These will have a serious impact on your credit score and it can take up to 6 years for their effects to disappear.