At some point in life, most of us will take a loan from the bank. Maybe you’ll need the money to study, or to buy a car, or to pay for your dream home. Ideally, you want the interest rate on that loan to be as low as possible, so that you don’t end up paying double or even triple the amount you loaned over the period.
How does the bank decide what interest rate to give you? They look at your credit score. And here’s the dilemma: credit (like a store card or credit card) can easily lead to accumulating bad debt, yet at the same it can be a key to helping you achieve a good credit score.
So, do you apply for the credit or not? As Uncle Ben said to Spider-Man: ‘With great power there must also come — great responsibility…’
What is a credit score and why is it important?
A credit score is a three-digit number that reflects your creditworthiness to potential lenders and financial institutions. The higher the number, the more likely that your application for a loan or more credit will be approved. This applies to a big loan like vehicle finance or a mortgage, but also to smaller credit lines like mobile contracts and store accounts.
Your credit score is based on your credit history, which includes your total amount of debt, how many open accounts you have, and your repayment history. Missed payments, for example, will impact your credit score negatively and lower your chances of acquiring more credit in the future. Your credit score will also determine what interest rate you’ll pay for future credit applications.
4 ways to build a good credit score
1. Pay your bills on time. Every missed payment can lower your score. When you apply for any form of credit, account or loan, make sure you can actually afford the repayment. Also consider setting up a debit order — that way you’ll never forget a repayment.
2. Don’t use all your credit. Your ‘credit utilisation rate’ is a fancy term for the percentage of credit available to you that you’ve decided to use. Using less available credit is generally seen as positive — it means that you’re keeping your spending in check. Also be aware that if you use the majority of your available credit on short-term, high-interest products like credit cards and store accounts, it could negatively affect your score.
3. Don’t apply for too many products. Multiple credit applications in a short space of time (especially to multiple credit providers) will raise a red flag that will negatively impact your credit score.
4. If you have a credit card, manage it well. Try not to spend wantonly on your credit card and be sure to pay the minimum required instalment each month. Even better, pay back the full amount.
At the end of the day, the credit scoring system is all about activity and balance: how much credit you use and how well you manage it. Building a history of good credit and responsible spending is important — it will improve your credit score, which will save you money through lower interest rates and open doors to loans that might improve your life in the long-term.
Master your money, not the other way around!
