What is a Credit Score, Why Does it Matter & How Can I Improve it?

What is a Credit Score and Why Does it Matter?

Most of us have heard the words “credit score” at some point in our lives, but many people couldn’t tell you what those words actually mean. This can be intimidating for some, but understanding the basics is actually a lot simpler than people think.

Your credit score affects more than just loan applications. Landlords, insurance providers, and even utility companies may use credit information when making decisions.

A good credit score can make borrowing easier and cheaper, as you may be offered lower APRs. A poor score may not necessarily mean you’ll be declined, but it can limit your options and representative APRs you’re offered may be higher.

Understanding how these scores work can help you make decisions to better your own financial wellbeing, that’s why in this article, we’ll be breaking down what a credit score is, what affects it, and steps you can take that could help you improve your own.

What is a Credit Score?

Lenders need to know how likely any given person is to repay what they borrow, regardless of if it’s a bank loan, or a car finance agreement. This is where credit scores come in. They provide lenders with a snapshot of your borrowing history and financial behaviour.

People often think that their credit score is a magic number, a mysterious financial grade attached to your identity that can never get better or worse and can affect several aspects of your life. But this isn’t true. While credit scores are important, it’s not a case of “the bank looked at my score and said no”, the score is simply one piece of a much bigger puzzle.

These scores are based on your financial behaviour over a long period of time, almost like a secondary school report. It’s less “how well you behaved this week” and more “a summary of your academic progress and performance over your time attending”

Now here’s the interesting part, there isn’t just one simple all-in official “credit score” that stays consistent everywhere, different credit reference agencies calculate scores in different ways. Some lenders may even use their own internal scoring systems alongside information from credit reference agencies. Don’t panic if one app says 720 and the other says 650, it’s not as bad as it looks.

This is why it’s typically better for the average person to focus on building healthy financial habits and responsible borrowing rather than chasing a higher number. Higher credit scores can help, but they’re not everything. Other factors such as income, affordability, existing financial commitments and employment status are considered too.

For example, take two people, both on £40,000 salary. One has a £250k mortgage, a car finance agreement for £450 a month and three loaded-up credit cards, the other has a £120k mortgage, a £200 a month car payment and no credit card debt. While both have a similar salary, their disposable income levels are completely different, meaning the person with a higher score, but lower disposable income, could struggle with certain borrowing more than someone with an average score and higher disposable income.

What Affects Your Credit Score?

Making Payments on Time

First and foremost, the biggest factor for the majority of people is making payments on time, missed payments can stay on your credit report for years. Typically speaking, one missed payment isn’t the end of the world, but lenders value consistency, repeated missed payments can have a bigger impact. It goes without saying that the current cost of living crisis makes this easier said than done, but budgeting and managing monthly outgoings is more important now than ever.

Think of it like trust, if you repeatedly promised a gardener you’d pay them on the first of the month, but make them knock on your front door on the eighth of every month asking where their money is, they probably won’t be cutting your grass for long!

The same applies to lenders, if you don’t pay, you become a higher risk.

If you are struggling to manage existing debt repayments, taking action as early as possible is important. Whether that's exploring a debt consolidation loan, a DRO, an IVA, or simply seeking advice, doing nothing often allows financial difficulties to become more challenging over time.

How Much Credit You’re Using

Most forms of credit, such as credit cards, have limits that are given to you at the time of application. Using all of this available credit can be seen as a warning sign to lenders, while maintaining a lower utilisation ratio is typically viewed more positively.

Simplified, this means someone with a £5,000 credit limit who is has a balance of £4,000, could be seen as a higher risk than someone with a £5,000 credit limit that has a balance of £1,200.

How Long You’ve Been Using Credit

Longer credit histories give lenders more information, even if your file isn’t perfect. Time builds a clearer picture, this is why closing old credit accounts isn’t always beneficial, lenders have more confidence reviewing 10 years of history rather than 10 months.

Applying For Lots of Credit in a Short Period

Applications for credit usually involve a “hard search”, these are recorded on your credit file. Making several applications for credit in a short space of time can create multiple hard searches, this could signal to lenders that a person is under financial pressure.

One loan application isn’t unusual, but five in a week may raise questions.

Electoral Roll Information

This is one most people don’t think about, registering to vote helps verify your identity, which lenders use to confirm who and where you are. It also makes it easier for lenders to match you to the information on your credit report.

If you are not already, registering to vote is one of the simplest improvements you can make.

The Information on your Credit Report

Errors can and do happen, old addresses, incorrect CCJs/Defaults, accounts that are not yours, all of these can have negative impacts on your credit score. Check your report occasionally, you can’t fix a mistake if you don’t know it’s there!

What DOESN’T Affect your Credit Score

It’s a common misconception that checking your score hurts it, or that your level of income is tied directly to it, or even that having a debit card doesn't build credit.

While we’ve outlined that multiple applications for credit can hurt your score, checking it regularly or even getting declined for credit doesn’t mean your score is getting annihilated.

How Can You Improve Your Credit Score?

The good news is that many of the factors that influence your credit score are within your control.

First and foremost, the most important thing you can do is make payments on time. Whether it's setting up Direct Debits to leave your account on payday or simply setting reminders on your phone, consistency is key.

Another simple win is registering to vote. It takes just a few minutes, costs nothing, and helps lenders verify your identity and match you to the information held on your credit report.

It's also worth keeping your credit utilisation manageable. Use emergency savings when possible, avoid maxing out credit cards and overdrafts where possible. Having credit available isn't necessarily a bad thing but regularly using most or all of it can be viewed as a warning sign by lenders.

If you're looking to borrow, try to avoid making multiple applications in a short period of time, particularly if you've already been declined. Applying for several forms of credit in the hope that one is approved can have an adverse effect on your credit file. If you're unsure whether borrowing is right for you, speaking to a lender first can help you understand your options.

Finally, be patient. Improving your credit score rarely happens overnight. Regularly check your credit report for errors, keep up with payments, and focus on building positive financial habits. Don't expect your score to jump the day after paying off a credit card – good long-term habits beat quick fixes every day of the week.

The Bottom Line

While credit scores can seem complicated at first, they're really just a reflection of your financial habits over time. They aren't fixed, and there is no such thing as a perfect score.

The good news is that many of the factors that influence your credit score are within your control. Making payments on time, keeping borrowing manageable, registering to vote and regularly checking your credit report can all contribute to a healthier financial profile over time.

Remember, improving your credit score isn't about finding a quick fix or chasing a specific number. It's about building positive habits, making informed financial decisions and staying consistent. Small improvements can add up, and good long-term habits will always beat quick fixes. Building positive financial habits doesn't just improve your credit score, it can also help you create a stronger financial future through regular saving and responsible borrowing.