How Does Your Credit Score Work?
When it comes to borrowing money, credit scores play a pivotal role. These scores are seen as a reflection of your financial responsibility and can have a significant impact on how much banks are willing to lend you and the interest rates they offer.
A good credit score can open doors to lower interest rates and better offers, while a poor credit score can limit your financial options. If you are looking for loans, credit cards or a mortgage, it is important to understand how credit scores work.
What is a credit score?
When you apply for a loan, your prospective lender will conduct checks on your creditworthiness and spending patterns to assess your ability to repay what they lend to you. To do this, they examine borrowing and repayment records, credit cards, overdrafts, hire purchase agreements, buy now pay later schemes, car loans, personal loans, mortgages, and even utilities like power, water, gas, and phones. Then you are assigned a score, a numerical representation of your perceived creditworthiness.
In New Zealand, credit scores typically range from 0 to 1000. These scores are generated by computer algorithms that analyse financial history and behaviour. The higher your credit score, the more likely you are to be approved for a loan and more favourable interest rates.
What different credit score ranges mean
1. Below 300: With a score below 300 many lenders may view you as highly risky.
2. 300 to 500: Scoring in this range may mean you face difficulties in getting a mortgage, and if approved, it could come with a higher interest rate.
3. 500 to 700: This range signifies an average level of risk, making you a more acceptable candidate for loans.
4. Over 700: A score over 700 is highly regarded by lenders, increasing your chances of loan approval and favourable interest rates.
What influences your credit score in New Zealand?
Credit scores are based on how well you repay debt, so if you regularly pay late, or worse, default on repayments, it will bring your credit score down. All financial ‘missteps’ will remain on your record for five years.
Your credit score is influenced by a range of factors, including:
1. Credit history: A long history of responsible credit use can positively impact your credit rating.
2. Outstanding debt: High levels of outstanding debt indicate significant financial obligations so can hurt your credit rating.
3. Payment history: Timely bill payments are crucial. Late or missed payments can harm your credit rating.
4. Credit utilisation: This refers to the amount of credit you are using compared to the total credit available to you. Using a high percentage of your available credit can lower your credit rating.
5. Frequent credit checks: Multiple credit inquiries in a short period may be seen as a sign of financial difficulties, potentially lowering your credit score.
6. Address stability: A stable residential address record can positively impact your credit score.
7. Length of credit: Do you have a lengthy history of borrowing and repaying, or is credit relatively new to you?
These days your credit score is more important than ever
Who manages your credit rating in New Zealand?
In New Zealand, we don’t have a single national credit score. Each of the four credit reference agencies assesses data differently, leading to variations in scores. Lenders in New Zealand also include positive reporting, which means timely payments as well as defaults, missed payments, and bankruptcies are reported.
How to maintain a clean credit record
Those with good credit scores tend to qualify for the best mortgage deals.
1. Manage credit responsibly: Pay your bills on time, and avoid late or missed payments, including court fines. Payment defaults can stay on your credit record for five years, even after paying the amount in full, and can lead to credit rejections or higher interest rates.
2. Reduce credit card debt: Pay off credit card debt promptly. Consider consolidating debt with a lower-interest loan to save on interest and pay off the total debt faster.
3. Seek support for debt issues: If you’re facing difficulty with debt, explore your options and seek assistance to avoid defaults.
4. Monitor credit checks: Be mindful of the number of credit checks performed. New Zealand has two types of credit checks: hard and soft. Hard credit checks are more comprehensive and are typically performed when you apply for credit. Soft credit checks, on the other hand, are for things like credit card offers or done by landlords and property management companies as part of the tenant screening process. Although they do not have as much of an impact on your credit rating, they are still recorded on your credit report. If you have a lot of soft credit checks in a short period, it may still be perceived as a red flag.
5. Check your credit file: Ensure that the credit information linked to your name is accurate and dispute any errors promptly.
Credit scores impact your ability to secure loans, credit cards, and other financial services.
While a not-so-good credit score isn’t a deal-breaker, it is something the lenders will look at. You may need to improve your rating before you will successfully get a home loan from a mainstream lender. So, if you want better financial opportunities, you should keep an eye on your credit score and practise responsible money management.