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What is a credit score?

Is it a magic number? Learn more about what a credit score really is.

02 May 2022Lloyd Smith 6 min read
What is a credit score? Personal finance, credit score range

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To get approved for a new line of credit, be it a new loan or a new credit card, banks first verify your past records to make sure you can actually repay your debt. Lenders use credit score as the main indicator to assess your creditworthiness.

In this article, we discuss everything there is to know about your credit score and how it affects you in the long-term.

A credit score is a three-digit number, usually between 300 and 850, which demonstrates your credit risk and your likelihood of paying debts on time. Potential lenders use credit scores while evaluating any credit application such as a loan or a credit card to understand whether they should grant you credit and at what rate of interest.

Your credit score is calculated based on your credit utilisation, recent payments, and several other factors. This includes the amount you have borrowed from various lenders, the number of credit applications you have made in the past, and your repayment history.

Equifax, Experian, and Illion are the three leading credit reporting agencies in Australia that decide your credit score on the basis of information in your credit report. Since they use different credit scoring models to arrive at the number, a good credit score and a bad credit score can vary according to the credit reporting body.

The short answer is yes -- having a high credit score gives you access to better offers and lower interest rates. It also means that more lenders are likely to approve your application compared if you have an average or below-average credit score.

When you apply for financial assistance such as a home loan, the bank wants to ensure that you are a responsible borrower and your credit score helps them to determine that, along with other factors.

If you have a higher credit score, you will also find it easier to get competitive interest rates and other terms with the lenders. On the other hand, low or bad credit scores can mean substantially higher interest rates or lenders can even reject your loan applications or other financial products.

You can think of credit scores as a risk assessment tool for lenders to make better lending decisions. While extending you a loan, banks and financial institutions (including credit card companies) want to know if you are at risk of defaulting on your payments. So they rely on your borrowing history to determine your credibility.

However, it is impractical for lenders to assess individual entries in your borrowing history. That’s why they rely on credit reporting by credit bureaus. Each time you make a payment or apply for a new line of credit, a credit enquiry is generated and marked in your credit report. A credit reporting agency compiles the information in a credit report, and assigns you a score using a credit scoring model.

Every credit reporting agency comes up with their own credit score range to classify whether the credit score is good or bad. You need to check the range of each agency to determine whether you are on the higher or lower end. But in most cases, the higher the credit score, the better.

The credit score range varies depending on the credit reporting agency, and every agency may award different credit scores to the same borrower.

The range of the score depends on the credit scoring model applied by the agency. I n general, here is an approximate breakdown of the range commonly followed:

  • 300-579: Poor
  • 580-669: Fair
  • 670-739: Good
  • 740-799: Very good
  • 800-850: Excellent

If you consider the Equifax score range, any score between 661 and 734 is considered ‘good.’ If you are between 735 to 852, it is ‘very good.’ If you are above 853, it is ‘excellent.’

In contrast, as per the Illion credit report, any score between 500 to 699 is ‘good’, and if you are 800 and above, it is excellent.

The credit score range also depends on the type of product you are applying for. For example, the minimum credit score for a credit card in Australia is above 622, whereas any score between 500 to 700 will make you eligible to apply for a home loan.

You can check your credit score in Australia with ClearScore to get a free copy of your credit report directly emailed to you.

Here’s how you can do it:

1 - Sign up with your email address on ClearScore

2 - Add details like your name, residential address, and date of birth

3 - Provide your registered passport, driver’s license or medicare number to verify your identity

4 - Get access to your free credit report and check your credit score

When you check your credit score, a soft enquiry is generated which does not affect your credit score. In fact, it is a good practice to check your score every 2-3 months. In case your credit score has been declining over the last few months, you can preemptively adopt credit repair strategies to improve it before it decreases any further.

Here are some factors that can turn can immediately turn your good credit score into a bad credit score:

Your payment history

Payment history plays a critical role in determining your credit score. A big part of your credit score is determined by your payment history, as lenders want to be sure that you repay your debts on time as a borrower. Missing even a single payment can wreak havoc on your score.

Your credit history

Poor credit history can bring down your credit score. In other words, how long you've held different credit accounts is important.

A credit reporting agency considers the age of your oldest and newest credit account while determining your credit score. The longer your credit history, the higher your score will be, whereas if you have too many new credit accounts, your score will not be as high.

Lack of credit mix

Those with a higher credit score tend to maintain a diverse portfolio of accounts. Their credit mix includes different personal loans, credit cards, and other credit products. So if you only have a single type of credit product, the chances are that your score will be on the lower side.

Having a healthy credit mix also means that you can handle the two main types of credit available - are two main types of credit— installment credit and revolving credit. Revolving credit or open-end credit is how a credit card works. You can incur expenditure up to the credit limit on your card, and once you repay the due, the original limit is restored. In contrast, an installment credit is a one-time thing. It involves loaning you an amount equal to the purchase amount you can repay in fixed installments.

You are likely to end up with a bad credit score if you don’t have a mix of these two types of credit in your portfolio, as it may give the impression that you are unable to keep up with two kinds of payments.

Applying for too much credit in a short time

Every time you apply for new credit, the lender conducts a credit score check. The credit inquiry shows up as a hard inquiry on your credit score report and can remain on file for up to two years.

If you have too many hard inquiries, it can bring your score down as it sends out a signal that you are unable to manage your financial situation well and are in constant need of new debt.

Pay your bills on time

This is one of the easiest ways to achieve a higher credit score.

Defaulting on bill payments or loan installment payments can push your credit score down by a few points, and such default continues to show up in your credit report for five years. Moreover, making regular payments subsequently cannot erase this information from your credit report.

You can set up auto payments from your checking account to never miss the due dates.

Think before you take on new credit

When you apply for a new credit product, such as a loan or a credit card, lenders perform a credit score check. Repeated credit enquiry can negatively impact your credit score. However, checks performed by borrowers to find out their individual scores are not considered a credit enquiry and don’t impact the score negatively.

Also, be wary of making new applications to increase your credit limit or simply move your debt around. Any credit application you make shows up on your credit report, and if lenders notice a pattern, it will be a potential red flag.

Reduce the available credit limit on existing cards

Having a credit card can tempt you to spend a lot more than you can afford.

Check the available credit on your existing cards and, if needed, request the credit card company to reduce it. It will ensure that you only incur debt that you can successfully pay off without borrowing additional loans.

To sum up, anyone with a higher credit score stands a better chance of accessing a variety of financial products at better terms. Therefore, it is important to keep a close eye on your credit score.

At the same time, demonstrating responsible credit behaviour is equally important. If you borrow only what you can easily repay, you will maintain a good credit score and become an attractive borrower for the majority of the lenders and receive more favourable credit terms.

With the help of ClearScore, you can routinely check your credit score in just a few clicks and build your score subsequently.

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Written by Lloyd Smith

General Manager AU

Lloyd spreads the word about how awesome ClearScore is.