How your credit rating affects the cost of borrowing

Banks and credit card companies use a variety of information to give you a credit score, which determines whether they’ll lend to you and on what terms.

Credit scoring can be based on:

• the information you provide on your application form
• what the lender might already know about you, based on other accounts you have made with them or previous applications, and
• your credit report at one or more credit reference agencies – the three main ones are Experian, Equifax and TransUnion.

Lenders often use an automated process to assess this information. However, each lender will evaluate and assess this information differently.

Lenders scores are different from the credit ratings a credit referencing agency will provide, which are only available to you and based on the information included in your credit report.

These ratings are designed to help you understand how firms might use your credit information to decide whether to offer you credit.

Credit referencing agency ratings only offer a general indication of how likely firms might be to offer you credit. Having a high rating doesn’t guarantee any particular business will actually offer you credit. This is because each firm uses its own criteria, which might vary depending on which credit product you’re applying for.

You’ll usually get a better credit score if you:

• are on the electoral register
• own your own home and/or have lived at the same address for at least a year
• are not connected financially, through your mortgage or a joint loan or bank account, to someone with a bad credit score
• have built up a good credit history by repaying credit agreements on time, as well as other bills (such as gas, electricity and mobile phone)
• have evidence of stability – for example, you’re employed rather than self-employed, you’ve lived at the same address, worked for the same employer and had the same bank account for a long time.

A poor credit rating could mean you:

• are charged higher interest rates
• are given a smaller credit limit
•  have your credit application declined.

A lender doesn’t have to give everyone the interest rate they’re advertising or that you see in best buy tables on comparison websites.

Some lenders operate on the basis of what’s called ‘rate-for-risk’ pricing. This is where the rate you get depends on the risk they think you represent of not repaying on time.

You’ll often see a ‘representative APR’ in advertising. At least 51% (just over half) of people applying for the product will pay this APR or better.

If the lender uses the ‘rate-for-risk’ pricing, up to 49% of people applying might be charged a higher rate.

This could be because they have a poor credit history or haven’t borrowed before.

Before you apply for credit, ask the lender what APR and interest rate you’ll be charged. However, some lenders might not always be able to tell you this before a formal application has been accepted.

If they need to do a credit reference check before quoting this, ask if they can use a ‘quotation search’ (which doesn’t leave a mark on your credit file). This is also called a ‘soft search credit check’ or an ‘eligibility check’.

This is useful either when you’re shopping around and not yet ready to apply for credit, or to check your eligibility before you make an application.

If your lender increases your interest rate, this will apply to your entire balance (except anything still covered by special promotional rates), not just new spending. This might mean you find it more difficult to keep up with your repayments.

Your lender will be taking into consideration a number of factors when making any decision on changes in the rate of interest. This could include information on your credit report or about how you’re managing your account. 

If an increase in the rate of interest you’re charged is due to risk then, if requested, your lender must give you a valid reason. 

If your credit card provider wants to increase your interest rate they must:

• provide a period of at least 60 days, from the date of you were first notified of the proposed increase (during this time you might give notice to your credit card provider to close your account)
• allow you to pay off the outstanding balance and over a reasonable period of time at the old rate of interest (before you were notified of the proposed increase in interest rate).

If you do choose to close the account, you could consider switching to a different credit card – for example, one that offers an interest-free period on balance transfers. However, if you have a poor credit rating, you might not qualify for these deals.

It’s important to also check for any fees associated with a balance transfer.

If you’re on a 0% deal, and forget to make a payment on time, the card company might remove the offer and increase your rate to the standard rate. If this happens, it might be worth contacting them and explaining why you missed the payment. If you have a history of managing your account well, the company might relax their rules.

Setting up a Direct Debit is a good way to make sure you never miss a payment again. But, if you’re income varies and you’re worried there won’t be enough money to pay the Direct Debit, making manual payments might be the better option. 

If you think you’ve been unfairly treated, complain to the lender first.

If you’re not satisfied with their response, you can complain to the Financial Ombudsman Service.