How your credit score affects the cost of borrowing

If you want to qualify for the most competitive loan and credit card rates then you need a good credit rating. What’s more, you need it to stay that way. This guide explains why.

How lenders decide whether to lend to you

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

Credit scoring can be based on information such as:

  • What you provide on your application form
  • What the lender might already have about you, based on previous accounts you have with them or previous applications, and
  • Your credit report at one or more credit reference agencies – the three main CRAs are Experian, Equifax and Callcredit

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 bank account, to people with a bad credit score.
  • Have a good credit history by repaying other credit agreements on time, and also other bills such as gas and electricity bills.
  • Have evidence of stability – for example you’re employed rather than self-employed, you’ve lived at the same address, worked for the same company and had the same bank account for a long time.

How a poor credit rating can affect you

A poor credit rating or score can mean you are:

  • Charged higher interest rates,
  • Given a smaller credit limit, or
  • Simply rejected outright.

A lender doesn’t have to give you the interest rate they are 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, where the rate you get depends upon the risk they think you represent of not paying the credit back on time.

You will 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.

In some cases, they all will, but if the lender uses the ‘rate-for-risk’ pricing up to 49%, might be charged a higher rate.

This could be because they have a poor credit history, or are new to credit.

Before you apply for credit, ask the lender what APR and interest rate you will be charged.

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 useful when you are shopping around and not yet ready to apply.

How your credit score can also affect your existing rate

Lenders don’t just check your credit score when you apply for a new card or loan, or before increasing the credit limit.

They might also regularly review all of their customers to check whether their risk status has changed.

If it has, the interest rate might be increased.

Essentially this means that if you fall into a certain group based on your credit rating, and the lender decides that group is now a higher risk than previously, they will put up the interest rate for all the people in that group.

There are additional obligations on credit card companies. In particular, they must:

  • Not increase the interest rate if you have a debt problem – for example, you are two or more payments in arrears, or a repayment plan has been agreed.
  • Tell you about any increase (they have to notify you individually unless the interest rate is linked to Bank base rate or another rate, or unless the increase is just because a promotional period is coming to an end).
  • Allow you to close the account, and clear the debt at the old rate of interest, if you notify them within 60 days following the increase.

So even if you’ve been a good customer and always paid on time you could suddenly face a hike in rates.

If you do elect 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 may not be eligible for these deals.

If you are on a 0% deal, and forget to make a payment on time, the card company may remove the offer and increase your rate to the standard rate. If this happens, it may be worth phoning them and explaining why you have missed the payment. If you have a history of managing your account well, the company may relent. Set up a Direct Debit to make sure you never miss a payment in the first place.

For more information on transferring a credit card balance visit our page: Should you transfer your credit card balance?

That’s why maintaining a good credit score is essential even if you’re not looking to borrow any more money.

Your rights if your interest rate is increased

It can be upsetting if a lender does increase your rate.

You might find it makes it more difficult to keep up repayments.

By law, a credit provider can only increase interest rates if it has a valid reason. If the increase is based on a change in the risk presented by the customer, the lender must tell the customer this and (if the customer asks) provide an explanation.

If you don’t understand this, ask – but they don’t have to explain what exactly it was in your credit report or credit score that has changed.

But credit card providers have signed up to a code of conduct and, while it’s not the law, they have agreed to give customers certain rights.

It’s important to know what they are so that you can check you’re being treated fairly.

What credit card providers have promised

Credit card companies have pledged:

  • Not to increase your credit card rate within the first 12 months as long as you don’t breach the account’s terms and conditions. After that, it can only increase your rate once every six months.
  • To tell you why your rate is being increased. Quite often the lender will state that it is because of your credit score, but if you can’t see any changes to your credit report then this might seem unfair.
  • To give at least 30 days’ notice of any interest rate increase, so you have time to pay off your debt in full.
  • To give you 60 days to close the account and clear the debt at the old interest rate in ‘reasonable time’, so you won’t be able to spend on the card anymore but you can keep repaying the existing debt at your previous rate.
  • Not to increase the interest rate if you have a debt problem. So, if you’ve fallen behind in your payments then talk to a not-for-profit debt counselling agency and ask them to negotiate on your behalf.

How to complain

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

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

Find out more about submitting a complaint on the Financial Ombudsman Service websiteopens in new window

What to do if your interest rate is increased

Sometimes you can forget to make a payment on time and lose your competitive interest rate.

The lender has a right to do that but it’s worth phoning them and explaining why you’ve missed that payment.

If you have a history of managing your money well then this will show in your credit report, and the credit card company might relent.

You could also switch to a different credit card offering an interest-free period on balance transfers.

This can help you clear any outstanding balance.

However, if you have a poor credit score then you’re unlikely to qualify for these cards.

You should also be aware that lenders usually charge a fee on balance transfers.

This is typically a percentage of the overall balance you’re transferring, so it’s worth checking this.

How to repair your credit rating

The guides below can help you start to improve your credit score:

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