The landscape of personal finance often involves understanding the ins and outs of credit scores. A key component in fiscal health, your credit score can influence your ability to secure loans, obtain credit cards, or even rent a home. But what constitutes a bad credit score? How is it calculated, and what potential impact can it have on various aspects of your life? This article will delve into these questions, providing a clear overview of what is considered a bad credit score in the UK, the factors contributing to a poor score, and the implications it may have on your financial opportunities. We will also explore the avenues available for improving a less-than-stellar credit score, ensuring you’re equipped with the knowledge to take control of your financial future.
Understanding credit scores
In the UK, three main credit reference agencies (CRAs)—Experian, Equifax, and TransUnion—compile credit reports and generate credit scores for individuals. Each CRA has its own scoring system, and they use different scales to represent your creditworthiness. Here’s a brief overview of each agency’s scoring system:
- Experian: 0-999
- Equifax: 0-700
- TransUnion: 0-710
While the exact methodology and calculations differ among these agencies, they all evaluate factors such as your credit history, outstanding debt, payment history, and the length of your credit history to generate your credit score.
What factors contribute to a low credit score?
Several factors can contribute to a low credit score. Here are some key ones:
Payment History: This is the most influential factor. Late payments, defaults, or bankruptcy have negative impacts on your credit score.
Credit Utilisation Ratio: This is the amount of credit you’re using compared to the total credit available to you. High utilisation can indicate risk and negatively affect your score.
Length of Credit History: The duration of time you’ve had credit accounts open. A shorter credit history can lead to a lower score.
New Credit Inquiries: Applying for many new credit accounts in a short period can lower your score as it may indicate that you’re a high-risk borrower.
Mix of Credit Types: The variety of credit accounts you have (credit cards, retail accounts, instalment loans, mortgage, etc.). A lack of diversity can negatively impact your score.
Public Records: Bankruptcies, foreclosures, and tax liens can severely harm your credit score.
Outstanding Debt: Carrying a high amount of debt can lower your credit score, especially if you’re close to your credit limit on several cards.
Collection Actions: Having an account in collections, or a history of them, can significantly decrease your credit score.
Remember that different credit scoring models may weigh these factors differently, and therefore, scores may vary between models.
What credit score is considered “bad” when applying for a mortgage?
The term ‘bad’ credit score can be somewhat subjective, as different lenders have different risk appetites and lending criteria. However, we can use the general credit score ranges provided by each CRA to better understand what might be considered a ‘bad’ credit score when applying for a mortgage:
- Experian: A score below 561 is considered ‘very poor,’ while a score between 561 and 720 is considered ‘poor.’
- Equifax: A score below 279 is considered ‘very poor,’ and a score between 280 and 379 is considered ‘poor.’
- TransUnion: A score below 550 is considered ‘very poor,’ and a score between 551 and 565 is considered ‘poor.’
If your credit score falls within the ‘very poor’ or ‘poor’ ranges, you may face difficulty securing a mortgage, or you may be offered less favourable terms, such as higher interest rates or a lower loan amount.
How is a credit score calculated?
A credit score is calculated using information from your credit report, which is a summary of your credit history. Each credit reporting agency has a slightly different method for calculating your credit score
It’s important to note that while these percentages are generally accurate, the exact weight of each factor can vary depending on the scoring model being used and the individual’s unique credit history. Also, the information available to the credit reporting agencies might differ, resulting in slight differences in your score from agency to agency.
What are the potential consequences of having a bad credit score?
Having a bad credit score can have a number of potential consequences, including:
Difficulty in obtaining loans or credit: This includes personal loans, mortgages, and credit cards. Lenders are less likely to approve applications from those with bad credit scores as it indicates a higher risk of the borrower defaulting on their payments.
Higher interest rates: If you’re approved for a loan or credit card, you might end up paying a higher interest rate than someone with a good credit score. This is because lenders charge higher rates to offset the increased risk associated with lending to someone with bad credit.
Difficulty renting a home: Many landlords check prospective tenants’ credit scores. A bad credit score could make it harder for you to rent a home, or it could result in a request for a larger deposit.
Utility and mobile phone contracts: Utility companies and mobile phone carriers often check credit scores when setting up new accounts. A poor credit score could require you to pay a deposit or could lead to your application being rejected.
Increased insurance premiums: Some insurance companies consider credit scores when setting premiums for policies, including home and auto insurance. A bad credit score could result in higher insurance premiums.
Employment challenges: While it’s less common, some employers, particularly those in the financial sector, may check credit scores as part of their hiring process. A poor credit score could potentially impact your job prospects.
Difficulty starting a business: If you plan to start a business and need to borrow money to do so, a bad credit score could make it more difficult to secure a business loan.
Are there any specific legal protections for individuals with bad credit scores?
There isn’t a specific set of legal protections for individuals with bad credit scores per se, as a low credit score in itself is not considered a protected characteristic.
However, there are laws and regulations that govern how credit information can be collected, used, and shared, which apply to everyone, regardless of their credit score:
Data Protection Act 2018: This law governs how personal data, including credit information, is used. It gives individuals the right to access their personal data, to correct inaccuracies, and under certain circumstances, to have their personal data erased.
The General Data Protection Regulation (GDPR): This European Union law still applies in the UK and provides stringent guidelines for the handling of personal data. It includes provisions that require companies to protect personal data and restrict how it is shared.
Consumer Credit Act: This law provides protection when you enter into credit agreements. It outlines rights such as the ability to withdraw from a credit agreement within a certain timeframe, and the right to repay a loan early.
Financial Conduct Authority (FCA) Regulations: The FCA oversees the conduct of financial firms providing services to consumers. It ensures that businesses operate with integrity and transparency, and it provides protections for consumers in their interactions with these firms.
These regulations and others can offer some protection for individuals with bad credit scores, particularly in terms of fair treatment and data protection. If you believe you’ve been unfairly treated because of your credit score, it may be worth discussing the situation with a legal advisor or the relevant regulatory authority.
What services or businesses use my credit score to make decisions?
Various businesses and services use credit scores as part of their decision-making processes. Here are some examples:
Banks and Credit Unions: These institutions use credit scores to decide whether to approve applications for credit cards, personal loans, mortgages, and other types of loans. Your score can also influence the interest rate you’re offered.
Auto Dealerships and Lenders: If you’re applying for a car loan, the dealership or lender will likely check your credit score to determine whether to approve your loan application and what interest rate to offer.
Landlords and Rental Agencies: Many landlords and rental agencies check prospective tenants’ credit scores. A poor score might make it more difficult for you to rent a property, or you may be asked to provide a larger security deposit.
Utility Companies: Some utility companies check your credit score when you establish service. If you have a poor credit score, you may need to pay a deposit.
Cell Phone Carriers: Similar to utility companies, cell phone carriers often check your credit when you establish service. If your credit score is low, you might need to pay a deposit or you might not qualify for certain plans or deals.
Insurance Companies: Some insurance companies use credit-based insurance scores, which are somewhat similar to credit scores, to help determine your premiums for auto and home insurance policies.
Employers: In some cases, employers may check credit scores as part of the hiring process, particularly for positions that involve financial responsibility. However, this practice is less common and is subject to certain restrictions.
Debt Collection Agencies: These agencies may use credit scores to help decide which accounts to pursue and what strategies to use when attempting to collect a debt.
Is it possible to improve a bad credit score?
Absolutely, it is possible to improve a bad credit score. The process can take time, but with a consistent approach, you can see improvements. Here are some strategies to help you improve your credit score:
Pay Your Bills On Time: Your payment history is a significant factor in your credit score calculation. Consistently paying your bills on time can have a positive impact on your credit score over time. This includes not only your credit cards and loans but also utilities and other bills.
Reduce Outstanding Debt: The amount of debt you owe, particularly relative to your credit limits, also affects your credit score. By paying down your outstanding debt, you can improve your credit utilisation ratio (the amount of your total credit you’re using), which can help to improve your credit score.
Don’t Apply For Credit Too Often: Each time you apply for credit, a hard inquiry is recorded on your credit report, which can lower your credit score. Try to apply for new credit only when necessary.
Maintain Older Credit Accounts: The length of your credit history contributes to your credit score. If you have older credit accounts that are in good standing, keeping them open can help to lengthen your credit history and improve your score.
Check Your Credit Report Regularly: Errors on your credit report can lower your credit score. You have the right to request a free copy of your credit report each year from each of the three major credit reporting agencies, and you should do so. If you find any errors, dispute them with the credit reporting agency.
Diversify Your Credit: Having a mix of different types of credit, such as credit cards, a car loan, a mortgage, can positively affect your credit score. However, this doesn’t mean you should take on unnecessary debt – only apply for and use credit responsibly.
Seek Credit Counselling: If you’re struggling to improve your credit score on your own, you might benefit from credit counselling. A credit counsellor can help you understand your credit report, develop a budget, and create a plan for improving your credit score.
Keep in mind that improving your credit score usually takes time. Be patient with the process, and be consistent in your efforts. With time and responsible credit management, you can see your score improve.