One’s credit history is a record of loans and overdraft facilities that have been registered against an individual and how
they have managed them. The information is collated and shared amongst Financial Institutes that are looking to offer a
line of credit to individuals as a way of assessing the risk of a person and on a larger scale looking at the risk of a
particular postal code area. Much like car insurance there are so parameters that are taken into account as they are
applied to the situation at hand. Much like insurance companies will look at the claims history of an individual, reasons
behind the claims and where they live compared with overall claims and then apply that information to the type of car the
individual wants, finance companies will look at how an individual has managed their debt before, the circumstances and
types of loans that have been acquired and apply that information to the request and reasons for the new loan to assess
the likelihood of successful repayment.
Understanding the system
To understand how finance companies assess individuals and apply the scoring system it is important to understand finance
companies and what the credit history shows. So, firstly understanding finance companies: The first thing to understand
correctly is that finance companies exist to LEND money. Secondly they make their profits by charging interest on the
loan had a higher rate than it costs them to access the funds to lend and to administer the loan. Thirdly, they do not
want their debtors to repay the money quickly, they want a loan paid back regularly over time. The ideal scenario for a
loan company is that all their funds have been lent out and all their debtors pay the amount agreed each and every month
with zero defaults, and when a loan comes to the end the funds are re-borrowed. Credit Card companies in particular do
not like individuals that clear their balance each month thus avoiding any interest payments. They prefer individuals who
actively use the card and meet at least the minimum payment amount each month.
So, now you have a better understanding of the motivation behind a lending company it makes it easier to understand how a
credit history score is recorded and how it is applied to an individual. Credit history shows a number of key bits of
information about an individual: The full name and date of birth; current address and previous addresses associated with
the individual and the credit arrangements; and finally all credit arrangements, including mortgages, credit cards,
personal loans and overdrafts, currently outstanding or settled for the last 6 years. It is this final section that the
score is applied to. For each of the credit arrangements the total amount of credit available or lent is shown (not
necessarily the amount outstanding), plus the last 12 months payments. However these 12 months of payment history are
not recorded as monetary amounts but rather as a score of 0 – 12. Zero means the full amount was paid off. One (1)
means the minimum or agreed amount was paid, two (2) means that one month was missed, three (3) means two months was
missed etc etc. From this the loans assessor can determine if you are a good credit risk, especially when they look
at the type of loan.
Good Score versus Bad Score
What makes a good score? A credit score that shows a mortgage and a couple of credit cards that are cleared each month would look something like this:
Scenario One:
| Mortgage |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
| C.C. 1 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
| C.C. 2 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
Ironically this is not considered a good score or a good risk. This shows that the individual pays his mortgage, probably by Direct Debit, each month and either doesn’t borrow on his credit cards or clears the balance each month. It does not imply that the individual understands or is able to cope with credit payments.
Scenario Two:
| Mortgage |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
| C.C. 1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
| C.C. 2 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
This scenario shows that the individual uses credit but more importantly understands that payments have to be made each month and meets those commitments. This is an ideal credit history. For a loan assessor now all they have to concentrate on is the amount wanting to be borrowed against income and other commitments and consider whether the individual has the disposable cash to meet the monthly payments. If they do there is a very high probability that the loan will be granted – unlike in scenario three that shows a distinct lack of control.
Scenario Three:
| Mortgage |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
1 |
| C.C. 1 |
3 |
- |
- |
2 |
- |
1 |
0 |
0 |
2 |
- |
1 |
0 |
| C.C. 2 |
4 |
- |
- |
- |
3 |
- |
- |
3 |
- |
- |
1 |
1 |
Knowing how you are rated enables an individual to correct a poor credit history within 12 months. Taking control of one’s finances and ensuring that payments are met each month is the best way back to becoming a “credit worthy” individual.