Welcome to Episode 3 of Whiteboard Wednesday with Paul Walshe. Today Walshy chats about how credit scores are calculated, including:
- What is a credit score?
- What does a credit score measure?
- How is my credit score calculated?
- How does my credit score affect my ability to borrow?
- How can I protect my credit score?
Welcome to Whiteboard Wednesday. I’m Paul Walshe, Founder and CEO of Fair Go Finance.So today’s topic is what is a credit score and how is it calculated?
So a credit score is not one credit score for a person. Credit scores are assembled or determined by credit bureaus. So the fact is that what a credit score measures is a perceived level of risk around you as a borrower.
So how likely are you to go into default in the next 12 months.
Now I’m talking generally here because there’s not one credit score, scores will range generally from 0-1000.
Unless you’re bankrupt and then your score sits outside that credit range.
What is used to measure your credit score? A lot of things around your behaviour and your credit activity. So you’re applying for a lot of loans, are you making payments on time on those loans, or have you gone into arrears or into default on those loans.
So that data that lenders share with the credit bureau is used by those bureaus to calculate your score.
Now the more recent the history is, generally the more powerful it is for creating your score, or determining your score, and if it’s ancient history it’s less important. But it still will play a factor in your score.
So as your score goes up, your probability of default comes down. Generally speaking, for every hundred points it halves your probability of default.
Now a large proportion of people sit in the range of 400-700, near prime and prime credit markets.
So the probability of default can drop from between either end from say 20% to 2.5%. That’s a significant drop if you’re a lender looking at different credit applications.
So it’s important you understand your score, it’s important you know what goes into it and it’s important that you check it by getting a copy of it from your bureau – copy of your credit file from the bureau – to make sure the information that’s going into your score is correct.
But really, before you apply, it really is important that you look around the market, don’t apply everywhere, look for a lender that you trust and be happy to deal with, someone who’s a licenced lender and treat you with respect. That’s something we try to do extensively at Fair Go Finance.