You and your credit rating
Your credit rating. A mysterious concept indeed, and one that produces a vague sense of unease: am I ruining it right now? Does it really matter if I am? And what the bejesus is it anyway? We shed some light on these questions.
What is a credit rating?
The term ‘credit rating’ refers to information used to assess how risky you are for lenders. In other words, how likely is it you’ll pay back a loan?
The credit rating is then used to produce your ‘credit score’. Credit referencing agencies are the guys who come up with this score using the available information.
Banks then use this data as their primary point of reference in deciding how much ‘credit’ they should give you at what interest rate, when, and for what purpose.
This applies to anything from overdrafts, to loans, balance transfers and mortgages.
Because having a bad credit rating can turn out to be a nightmare when you’re applying for loans, credit cards, mortgages – any type of credit at all. This means (yes it sounds clichéd) a little attention in the early stages saves a lot of hassle and money in the long run.
A good credit rating saves you money in the long term
A poor credit rating makes it more expensive to borrow money.
The fact is that the overdraft extensions, the 0% interest free balance transfers and even the most lucrative loan offers out there all depend on having a good credit rating. If your credit rating deteriorates, you may even end up with a large amount of debt on one card that you are unable to transfer.
Although you may not be planning on getting a mortgage six months after graduation, be aware that something that seems pretty insignificant like a bounced phone bill payment (even if you do pay it pretty soon after) can affect you later on.
Let’s take an example to illustrate this. Suppose you racked up £500 worth of credit card debt that you were unable to pay off for two years, and you regularly made the minimum payment (in this example 5% of outstanding balance) to your account. Working through the example you can see how a good credit rating- one that allows you a lower interest credit card of 12.5% APR will work out substantially cheaper than if you had a low credit rating, and could only borrow at the higher threshold level of 18.5%.
| Year | Outstanding Balance | Interest Paid |
|---|---|---|
| Year 1 | £500 | £47.88 |
| Year 2 | £305.96 | £29.22 |
| Total interest paid | £77.10 |
| Year | Outstanding Balance | Interest Paid |
|---|---|---|
| Year 1 | £500 | £70.72 |
| Year 2 | £308.07 | £45.57 |
| Total interest paid | £116.29 |
