There’s one scenario for home owners that’s quite heartbreaking, and not just upsetting because of the outcome. It’s painful because it’s a scenario that’s avoidable. Here it is: a happy couple or savvy bachelorette/bachelor saves up for a deposit, sets their sights on a nice little two-bedroom apartment not far from the city…and then their home loan application gets knocked back. They were completely sold on getting the keys to their very own kingdom with no major hiccups along the way, but they’ve been denied because of a bad credit score. Cue sad trombone.
Who knew such a thing as ‘credit score’ existed? What is it? And how does it affect your home owning potential? If you have a credit score which is killing your home-owning dreams, you need to understand what your credit score is before you can start to turn the tables back in your favour.
What is credit score and why do we need it?
According to the Australian Retail Credit Association, a reported 59% of Australians don’t understand what credit reporting is, so don’t feel bad if you’re like half of this country.
Your credit score – which is derived from your credit report – is data that lenders use to assess whether or not you’re creditworthy. If you’ve held a credit card, taken out a personal loan, had a mobile phone or had a utility account in your name within the past 5 years, you’ll have a credit report and a credit score.
Your credit score is affected by your payment history, which is all detailed in your credit report. If you default on your payments or are consistently late paying bills, your credit score is likely taking a hit. Yep, all those times you forgot to pay your phone bill do add up. If you’re paying your bills on time and making the minimum monthly repayments on your credit card or loan, then bravo. Your credit score will be a shimmering display of your financial discipline.
So, you’re probably wondering who gets to decide whether your credit score is good or bad. Who on earth holds such power? There are a few companies in Australia that control this information, the top two being Veda and Dun & Bradstreet. Creditors – like banks and utility companies – send this information to these credit bureaus, where they compile your credit report and score. With this information handy, they’ll be able to pass this data on to lenders, who then assess whether or not you have the capacity and discipline to pay back a loan.
What is a ‘bad’ credit score?
In Australia, credit bureaus will compile your credit data and use a rank-ordering tool to assess your credit worthiness. If you want to find out your credit score, you make an enquiry with them. But banks will also have their own credit scoring system, so don’t think that your score with Veda is definitive and binding. Each lender will work out your credit score differently depending on their criteria for credit worthiness. What might be a ‘bad’ credit score might not be so ‘bad’ for others.
So what affects your credit score? Everything in your credit file, which includes:
- Details of your overdue debts and defaults (missed payments) on loans
- Previous applications for credit
- The number of time you’ve made credit enquiries in the last five years
- The types of credit you’ve applied for
- The names of lenders who’ve provided you with credit
When you go to apply for a mortgage on your first home, the lender will place an enquiry with the credit bureau to get your credit report. Using this report, the lender will be able to use their own credit scoring system to calculate your credit score. Depending on their policies and procedures, they may or may not grant your application.
How do I check my credit score?
Everyone is entitled to one free credit score report per year. These reports are free, but if you want your report quickly you do have the option to pay for this service. We recommend using Veda’s free service.
How do I improve my bad credit score?
It used to take quite a bit to tarnish your credit score. Whereas huge financial events – like bankruptcies or going AWOL on your bills – were the main offending behaviours, it takes much less to disrupt your credit history today. If you’re more than 14 days late with payment on your credit card, phone bill, rent or even a retail offer, the credit bureaus are going to hear about it.
Let’s say you’ve received your report back from Veda, and it’s not looking like you’ll be getting that bachelor pad anytime soon. Unless you want to pay higher interest rates, it’s in your best interest to improve your credit score.
My advice to you: don’t lose heart. Empower yourself with the knowledge that you can turn things around. Here’s how you can start:
Look out for mistakes on your credit report
Hey, these things happen. In fact, back in 2013, a survey by the Office of the Australian Information Commissioner found 30% of Australians spotted errors on their credit reports. Only 60% of those people sorted it out. Don’t get angry. Just get it fixed. Look out for things like closed accounts that still have a balance owing and default errors, then get your credit report fixed.
Pay your bills on time
It seems a bit unfair that the credit bureaus would even snoop into your Foxtel account, right? But if you’re always late with the Foxtel bill, lenders will assume you’ll treat your home loan no differently.
The best way to pay your bills on time is to set up direct debits. That way, you won’t even have to think about it, and you can dedicate more energy to saving for your home loan.
Pay off your debts
If you have a few outstanding balances on credit cards and personal loans, speak to your lenders about rolling these into one. Why? Having one interest rate and one account will help you fast track your payments. If this isn’t an option, try the snowball method, which I talk about in this post.
Don’t max out your credit cards
Just because you have a $3,000 limit doesn’t mean you should use all of it. Why? Because if you go over the limit, it can show up on your credit report. If you’re hitting your limit, you either need to reduce your spending or increase the limit.
Don’t shop around
Every time you apply for credit, an enquiry is recorded on your credit file whether you take it out or not. This includes utilities, phones, and obviously finance. Too many enquiries can affect your credit score.
The key is to weigh up your options beforehand, or get your friendly mortgage broker to help you out. But only ever apply at one lender.
It’s important that you not only understand what your credit history is, but that you also take steps towards improving it. Leave it another day to worry about, and you could squander your chances of getting a home loan approval. And FYI, a rejected home loan application will also tarnish your credit history.
This is why it’s so important to get your finance right the first time with an expert guiding you.
Reach out now. My advice is free, genuine and tailored to help young first home buyers.