How Your Credit Rating Affects Your Cost of Borrowing
If you’re thinking about borrowing money in any way, whether that’s making instalment payments on a car, signing a mobile phone contract, or getting a straight-up loan, then your credit rating is incredibly important. Just how does that credit rating affect your cost of borrowing? Keep reading to find out.
What’s My Credit Rating?
Before we get into the details, let’s just quickly review what a credit rating is. Every adult in the UK has a credit rating. This rating is based on your financial history. It takes into account how good you are at repaying money you’ve borrowed, how good you are at paying your bills on time, and various other money-related matters, such as whether you’ve ever declared bankruptcy. If you’ve never borrowed money before, if you don’t have a bank account, if you’ve recently moved to the UK, if you’ve never had a credit card, or if you’ve just turned 18, your credit rating will be zero.
Your credit rating can be improved (for example, by getting a credit card and always making the payments on time), or can worsen (for example, by failing to pay your bills on time). There are three agencies in the UK that track credit ratings, and you can get a copy of your credit history from any one of them if you’re interested to see where you stand:
How Your Credit Rating Affects Borrowing
In very basic terms, a good credit rating generally means that companies will be more willing to lend money to you, or to trust you to pay your bills on time, since your past history shows that you’re reliable. A bad credit rating means that companies will be less likely to lend money to you. There are three main things that can happen if you have poor credit and apply for a loan or other form of borrowing:
- You can be denied outright and not be allowed to borrow
- You can be allowed to borrow, but at a higher interest rate than others
- You can be allowed to borrow but with a smaller credit limit (so, for example, you might be allowed only to spend up to £1000 on your credit card, as opposed to someone with good credit who will be allowed to spend much more)
The interest rate on a loan is the percentage extra that you must pay for the privilege of borrowing money. If you have bad credit that percentage will be higher. Be aware that although you may see plenty of advertisements with interest rates on them, these are not necessarily the rates that you will pay. By law, a company only has to give advertised interest rates to 51% of applicants, they are free to charge the other 49% of applicants more or less.
Obviously, having a good credit rating is far better for you if you’re planning on borrowing, so you might want to take a little time and check your credit rating before applying for any kind of borrowing. If you find that your credit rating is poor, it’s best to work for a few months on improving your score before moving on with your loan application!
Pro Tip: Before signing anything always ask the company in question exactly what interest rate you’ll be paying. Some companies may need to run a credit check on you before they can tell you this. If this is the case, ask them to run a “quotation check” since by doing this they won’t leave any trace on your credit rating file (too many checks on your credit file in a short time will decrease your credit rating since it looks as though you’re applying for many loans at the same time).
How Credit Rating Affects Current Borrowing
But your credit rating doesn’t just affect whether or not you’re allowed to borrow money, it can also affect money that you’ve already borrowed. Many companies will continue to run regular credit checks on you as long as you’re contracted to the company. If your credit rating gets worse over time (or if a company suddenly decides that they want to take less risks so change the limit of what they consider a “good” credit rating), then your interest rates could go up!
This is why it’s important to keep on top of your credit rating, to keep paying your bills on time, even if you’re not currently considering borrowing any money at all.
Your Interest Rates Are Increased
If a company does increase your interest rates then you might find it more difficult to keep up with payments. Plus, of course, you’ll be paying more in the long run for borrowing. But there are some caveats here, and there are a few things you should know:
- Providers can only increase interest rates with a good reason, and if you ask them why, they must tell you (this could give you the opportunity to fix any problems if, for example, the cause is a problem on your credit report)
- Providers must tell you about an increase in interest rates BEFORE increasing the rate (if they didn’t, then you’ll have cause to take legal proceedings against the company)
- Providers must allow you to pay off the debt/loan at the OLD interest rate within 60 days of the change in interest rates (so if you do not wish to pay the new rate, you can pay off the loan altogether), AND allow you close your account without penalty once the debt/loan is paid off
- Providers can NOT increase your interest rate if you clearly have a debt problem (if you have missed more than 2 payments, if you have already discussed a debt repayment plan with the company, or if you’re undergoing a debt consolidation process)
- In the case of credit card companies only, your interest rate can not change within the first 12 months (assuming you keep to all contracted conditions), and cannot change more than once every 6 months after that
The bottom line here though is that if your credit rating does get worse, even your current borrowing could be affected.
Rating Affects Borrowing
There are all kinds of companies that check your credit rating, from your mobile phone operator to a mortgage broker, and that rating can severely affect your chances of borrowing or signing contracts. This is why it’s so important to keep an eye on your rating and do all that you can to keep it high. Fortunately, there are ways of improving your credit rating if it should slip.
Apply for your credit rating from one of the three agencies mentioned above about once a year, or before any major credit purchase to ensure that you’re in good shape. And if you do run into any problems, all three agencies have dispute processes that allow you to potentially change mistakes on your report.
In the case of current borrowing, should your interest rate change you have the right to know why. And should you feel that your provider has not fulfilled their obligations, or if you’re not satisfied with the way you’ve been treated, then contact the Financial Ombudsman Service for further help.