Credit Scores: Inside the Machine
As humans we're inherently hard-wired to distill any benchmark of performance to a single, observable metric. How much did you indulge over Christmas? Step on a scale. Need a gauge of academic performance? Check the GPA. Want to test how smart you are? Take an IQ test. We're comfortable assigning disproportionate weight to single figures as barometers for our physical health, intelligence and academic ability despite them being flawed. We know the number on the scale doesn't reflect overall health (entirely dismisses your body fat %, hydration levels & skeletal composition), we know IQ tests are often a poor overall measurement of broader intelligence. What about financial health? Is there a single, unambiguous, analytics driven figure encapsulating the credit card splurges, mountain of student debt or string of failed debit orders?
Yes - your credit score!
Despite this being the single most important number of financial wellness, many people aren't in full control. The latest TransUnion Financial Hardship Report shows 28% of people don't monitor their credit scores - at all. An alarming 32% of respondents feel monitoring credit during COVID-19 is either "slightly important" or "not at all important".
Full report: Financial Hardship Report
Not knowing your credit score is the equivalent of driving without ever glancing at the fuel gauge.
How is my credit score calculated?
The thought of sophisticated machines devouring data and crunching through multiple complex algorithms only to fire out a single number sounds intimidating. It shouldn't be.
Here are the 7 main elements that play an important role towards your credit score:
1) How you pay your credit obligations both current and historically
2) How much and often you utilize credit made available to you
3) The length of time you have actively used credit
4) Total amount of recently (past 6 months) opened credit account balances
5) Number of new credit accounts opened (past 6 months)
6) Total credit available to you across all credit products
The most important aspects of your credit score is your payment performance (are there frequent late payments?), how long you have been managing your credit (do you have a track record?) and credit utilization (are you suffocating in debt?).
The most important takeaway here is that you're always fully in control of influencing your credit score. None of the contributors rely on an opinion or a judgement call - fortunately, they're based on observable, tangible and unemotional data points. These values are crunched and you arrive at a credit score.
What is a good credit score?
Match pretty much has a monopoly over global dating apps, they own Tinder, Match.com & OkCupid covering over 60 million global users. Match decided to run a national survey to find out exactly how important a credit score is when it comes to attracting a potential partner. For 58% of online daters, a good credit score is more attractive than a nice car. Survey Press Release: Online Daters
Half of the respondents prefer a good credit score over an impressive job title and 40% took a good credit score over a physically fit body. Close to 70% said financial responsibility is more attractive than sense of humor or overall attractiveness. [Disclaimer: this does not constitute dating advice].
TransUnion credit score bands range from 0 to 999.
0 - 615 Poor
616 - 729 Fair
730 - 821 Good
822 - 917 Very good
918 - 999 Excellent
How can I improve my credit score?
There are practical & immediate steps you can take to quickly improve your credit score (& potentially secure that financial date).
- Keep an eye on your overall available credit: Having too much available credit can sometimes harm your credit score. Credit or service providers may feel that you have the ability to spend more than you could potentially pay back. It makes sense to accept only the credit you require instead of carrying high credit limits as this unused credit reduces your ability to borrow more. You might want to consider closing a few inactive accounts or asking to have your credit limits reduced. Qualifying doesn't always mean affordability. "Congrats! You qualify for a new BMW M4" doesn't actually mean you will be able to afford all of the costs that come with running an expensive vehicles (insurance, maintenance, security, etc.).
- Keep your account balances reasonable. High levels of debt can signal to potential credit or service providers that you are spending more than you can afford. It is a good idea to use your credit cards regularly but remember to keep your balances below 35% of your available credit limit. If you have balances above 35-50%, you could see your credit score start to drop. Before booking the vacation to Bali it's definitely worth running the numbers first to make sure you can repay it as quickly as possible.
- Pay on time: Late payments will drop your score. Always pay at least the minimum amount on your credit account each month. Missed payments materialize as your inability to keep with obligations on your credit score which lenders will view as negative in deciding to grant you additional credit.
- Have fewer accounts: Looking for new credit can equate with higher risk if the enquiries are done across many different industries within a short period of time. Opening several credit accounts in a short period of time affects your credit score. The impact from applying for credit will vary from person to person based on their unique credit histories. Building a good credit profile does not require you to take on 10 different store cards. Apply and pay on time for credit that you require and will use.
- Keep your public records clean: Listings such as judgments, debt review flags and sequestrations on your credit report are items of public record, which means that anyone can see them. An item in this category will significantly lower your score. Payment of these types of items will not immediately undo the damage to your credit score so preventing going into a legal dispute with a credit or service provider resulting in a public record is thus highly advisable.
I defaulted on a payment, it still shows up on my credit report. Why isn't it gone?
Credit bureaus are required by the National Credit Act (NCA) to retain credit bureau information on the consumer's report for certain prescribed retention periods - regardless of whether it reflects negatively or positively on the consumer. This information may not be removed before the prescribed data retention period.
This enables banks and financial institutions to make informed risk decisions when deciding on whether to grant you credit.
Killing the Credit Score Myths:
Conversations around credit scores are filled with popular (and dangerous) misconceptions. Here are the facts:
Factors such as your age, income level, employment history, ethnicity, religion and marital status are excluded from your credit score calculation. Your credit score will not drop by requesting your free credit report.
Your credit score may be slightly different across different credit bureaus. It's worth checking reports across each bureau to make sure they're correct. It is also worth noting that banks and financial institutions adopt more than one scoring method including affordability tests and consider a wide range of information when making a lending decision. A healthy credit score is one component of the overall information they use. Banks and financial institutions may differ in your application approval and this is down to how they differ in their own risk tolerance for lending. So always check available options for credit across institutions when applying for credit.
A poor credit score is not a life-long financial death sentence - you are in full control of your credit score and can completely rehabilitate your score through healthy behaviours.
I'm scared of my identity being stolen, personal details leaked and my credit record ruined.
This is a completely normal fear especially in digital age of data breaches where personal information translates to currency. Identity theft insurance is something to seriously think about when considering the potential downsides. TransUnion recently launched TrueIdentity which monitors the dark web for breaches of your personal information, access to a forensic investigator and insurance against identity theft. It also includes protection against unauthorized EFTs. You can check it out here: Protect your TrueIdentity
What can I do in the next 5 minutes to take charge of my credit score?
Start from a position of strength. The National Credit Regulator mandates all bureaus to allow consumer to access their credit report free of charge once per annum. You can access your TransUnion credit report for free once a year here: Information for Greater Certainty
Most importantly, it's an opportunity to check all of the information on the credit report is correct. You may actually have a reduced score because of an item which doesn't belong on your report.
In an age where we measure and analyze every miniscule feature of daily life, from step counts to quality of sleep, a credit score is one set of numbers which directly influences our quality of life and our entire financial experience.
Own the numbers.