Tembo's Guide To Credit
Credit is important when you want to buy a home. Read our guide to credit.
What is a credit score
Credit score is a rating that demonstrates how well you handle credit. Sounds obvious, right?
A score can be affected by how much debt you have and how well you pay it back. If you have a high credit score, you demonstrate a low risk to lenders. This means that you are more likely to be accepted for a mortgage. It also means that you will have access to better interest rates, than if you had a low credit score.
Why a credit score matters when buying a home
A mortgage is one of the biggest loans you’ll likely have in your life. So, your credit score matters as it demonstrates to lenders that you are likely to make those monthly payments. If you have a low credit score you may be less likely to be accepted for a mortgage.
Why is an excellent credit score better?
Customer who have an 'excellent' credit score are 25% more likely to get a lower mortgage rate than those who have a 'good' credit score, according to Experian.
Credit score also really matters when it comes to securing a rate for your mortgage. When you have a lower rate, you pay back less interest over time compared to if you have a higher rate. Larger lenders (such as big high street banks and building societies) offer some of the lowest rates, but only accept those with good credit scores.
If you have a small deposit of 5% and need a 95% deposit, there’s a high chance that you will need to have a higher credit score to take on the size of the debt.
When are credit checks made?
A buyer’s credit score is checked at different stages of the mortgage process, and a mortgage broker will also conduct credit checks. Once a mortgage broker has arranged an Agreement in Principle, they will conduct a quick credit check with whichever lender they have selected for you to make sure that your credit is suitable for the lender.
Lenders typically tend to check your credit with a soft footprint - meaning that only you can see that you have made an application for credit. A hard footprint means that your applying for credit is visible by any lender or company. When you make a full application to the lender you will be credit checked again with a hard footprint.
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What affects credit score?
If you don’t pay credit commitments or bills on time (or not at all) this could reduce your credit score. If the late or missed payments are recent, it will be more damaging to your score.
Receiving a default of County Court Judgment (CCJ) will mean that you lose even more points.
Using a credit card up to its limits can also be detrimental to your credit score, as it demonstrates to lenders that you are relying on credit to support your lifestyle.
Having an overdraft could also affect your credit score if you have been overdrawn for an extended period of time, as this suggests to lenders that you find it difficult to manage your finances.
What is a good credit score?
According to Equifax, an excellent credit score is 800+. Anything between 670 to 739 are considered good credit scores.
Does it matter if I have little credit history?
If you have a low credit score, but no history of missed or late payments, it may be because there is little or no credit activity on your file.
When there are few examples of you taking out credit, there is little that lenders can assess you on when considering how creditworthy you are. Students are likely to have a lack of credit history, or people with bank accounts that are empty or not in use.
Does Klarna affect credit score?
A recent change to buy now pay later schemes (specifically Klarna), is that the amount owed will now show as a credit commitment on your credit file. So, if you are applying for a mortgage, the lender will take into account any remaining monthly payments you have for buy now pay later schemes as a credit commitment - in the same way a loan or credit card payments are calculated into affordability.
Whilst this change seems like a big deal, it shouldn’t affect too many applications. A lot of the time, buy now pay later loans tend to be for a small amount. So, as long as you plan to have paid off the loan before you move into your new property, lenders won't take it into account as part of your outgoings.
It is important to note that you should make at least a minimum payment each month. This means the loan won’t have any negative impact on your credit score.
The impact of a bad credit score
Having a bad credit score means that you could be refused for a mortgage, or you could be penalised with higher interest rates, depending on your situation.
How to improve credit score
It’s a good idea to keep on top of your credit score by checking your report each month. You can sign up to credit agencies such as Experian and Equifax to do this.
Here are some easy ways to improve your credit score:
- Apply to be on the electoral roll. Being on the electoral roll automatically increases your credit score.
- Sign up to CreditLadder. If you are renting, you can report your monthly rent payments to CreditLadder to boost your credit score
- Taking a small amount of credit and paying it off straight away. Using your credit card to pay for a weekly food shop, and then paying it off straight away, shows lenders that you can manage debt.
- Get a credit-building card. If you have a bad credit history, a credit-building card can help prove that you’re creditworthy when you pay a bill of each month. However, credit limits on these cards are often low, and interest rates are high.