What bad credit scores mean for personal loans
Friday, 11 September 2009 12:00
The gloomy news that has characterised the financial crisis is not getting any better for people with anything less than stellar credit.
Problems as minor to not being on the electoral roll to a missed mobile bill can make obtaining an unsecured personal loan nearly impossible in light of the current economic conditions.
Despite obstacles, there are still opportunities to improve financial standing and become a more desirable loan candidate.
Kelly Gilblom tries to uncover the surreptitious tricks to improving your credit score.
What is a credit score?
Credit scores are measures of potential borrowers' creditworthiness. They are information gathered from credit reference agencies to be sold to lenders.
In the UK, this has become commonplace and credit scores are now the largest determinant of whether a customer will be approved for a loan, credit card or mortgage.
There are three major credit reference agencies that compile information. These are Experian, the most popular, Equifax and Callcredit.
The score they compile is a snapshot of the risk a borrower will be to a lender. It is composed of payment history, bank account information and other statistics such as duration at each address, job and marital status and the amount of times the credit score itself has been checked.
The report also includes criminal court judgments (CCJs), defaults and bankruptcy claims.
Information on the credit report is often not permanent. For example, payment history for credit cards or mobile phone bills date back six years after the account is closed. However, CCJs or mortgage defaults remain on record forever.
Though most lenders keep their scoring techniques a secret, the highest scores are usually awarded to those who have a good payment history with a number of different types of credit (i.e. mortgage, credit cards, loans), are on the electoral register, have maintained a steady job, have lived at the same address a prolonged period of time, are homeowners, are older rather than younger and are married.
Credit scores are considered by most banks and building societies to be unbiased because they make no mention of gender, race, sexual orientation, religion, medical history, criminal history or salary.
How is the credit score used?
Credit scores tell lenders the amount of risk they are taking on by awarding you credit.
Banks and building societies will turn down potential borrowers for not meeting the criteria they stipulate. Sometimes it's as insignificant as not being on the electoral roll as many lenders use this to confirm name and address.
"Even a slight blip, such as a missed mobile phone payment can be cause for rejection. A few years ago that might not have counted against you. Some people think they can just pay the bill a week late and it won't be a big deal but it really matters," says moneysupermarket.com's head of loans Tom Moss.
Usually, a bad repayment history is the culprit for being turned away. By law, lenders must tell rejected applicants why their loan was turned down and what credit reference agency they used.
An answer of, "the score wasn't high enough" doesn't suffice.
Sometimes a low credit score doesn't mean you will be turned away completely. The bank or building society may offer a loan for a smaller amount or at a rate higher than advertised to compensate for the additional risk.
Unfortunately, applying for a loan without knowing the rate can set you up for a "rejection spiral".
Every time your credit score is checked, it shows up on your credit report. A number of checks signals you are desperately seeking credit- often grounds enough to be turned down for a loan.
And in the current economic environment, the standards have become incredibly strict. Gone are the days of awarding credit to any and all applicants.
Mr Moss says: "Given what the banks and building societies have been through, any risky lending is being turned away."
People are now being declined credit for any small ding, leaving less than ideal applicants in a predicament.
What can be done?
The best way to keep from being turned away from a loan is to improve your credit score. This may seem obvious, but it can be difficult and timely in practice.
However, there are some things that can be done in the immediate future.
First, pay any outstanding bills and debt where able.
"You need to use your savings - if you have any," continues Mr Moss.
Cancel any credit cards or forms of credit that are not being used as these count against you.
Next, obtain a copy of your credit report. Experian, Equifax and Callcredit are now legally obligated to provide you with a statuary credit report for £2.
Customers can get more detailed credit monitoring for a price, usually around £70 a year. Free month long trials are often available although it is important to cancel before the expiry date or it can be very costly.
Look over the credit report and make sure all the information is completely accurate.
"Look at your credit records and be sure that it is an accurate portrayal of your credit history," says Mr Moss.
"You need to make an effort to correct mistakes on your credit report."
If you find there is a mistake or even evidence of fraud you can appeal to the credit reference agency to have it fixed.
If the agency refuses or if you have missed payments for a reason such as losing a job, illness or divorce, you can submit a 200-word document known as a "notice of correction". This should be a frank and honest explanation of why payments were missed or clarification of an error.
When writing a notice of correction, do not embellish, lie or go on about irrelevant information. These can all hurt you as potential lenders can see them.
However, notice of corrections can be an asset when used properly. Lenders may see missed payments as a one time thing if they happened for a legitimate reason.
You also need to be wary of joint finances. If your name is on a bill then it will go on your credit report regardless of your standing with the other party.
Whatever you do, do not use a credit repair service. They can not legally do anything that you can't already do yourself for free.
Ultimately, stability and paying off bills on time will be what makes you a viable candidate.
"Make sure you always pay your bills on time. It may seem simple, but it really makes a difference," says Mr Moss.
He adds: "For people with no credit or bad credit, there are credit builder cards out there that can help you prove you can handle your finances."
In the end, it's about being the type of borrower that a lender sees as profitable and stable.
Loan options
A few years ago lenders were granting unsecured loans to practically anyone. Now, obtaining a loan with a bad credit score is "virtually impossible" says Mr Moss.
Bad credit loans were a financial product designed for people who had CCJs or had declared bankruptcy but the credit crunch has caused them to virtually disappear off the market.
"There practically are no more bad credit loans. The only group doing that is Provident Financial but otherwise there is really nobody out there lending to people with poor credit," he continues.
"We've lost so many lenders."
If someone claims to be doling out instant bad credit loans, use caution. Often they are scammers.
Using a guarantor - someone to make good of the debt if you default on payments - or using the equity in your home as collateral are real options. However, those are both extremely serious commitments and should be discussed with a financial adviser.
Peer to peer lending is also an option. Websites such as Zopa.com, connect individual lenders and borrowers whilst completely surpassing banks and building societies.
The important thing is to use a trusted lender. If an offer sounds too good to be true it probably is. And lenders should never ask for fees up front.
"Customers should be very wary of anyone offering any type of loan for a fee," warns Mr Moss.
"What happens is you pay the fee and the money never appears. Then you have to go on a chase trying to get your money back."
When searching for loans, use comparison sites to browse rates. Do not apply for credit often and within a short time period to find deals as this will wreak havoc on your credit score.
Unless you are making an actual application for credit, lenders should not run a full credit check on you - so don't let them. You will be the one paying the price.
Last, if you are in a situation that seems impossible; do not ever lie to get credit. Untruths can be easily discovered and will count as a fraud on your record making it nearly impossible to obtain credit in the future.
If you are in debt or need serious help go to your local Citizens' Advice Bureau for a start.
"People who are considered in the bad credit group total about 10 million," says Mr Moss.
You don't need to be one of them.
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