How applying for credit affects your credit score

Is it really true that you reap what you sow when it comes to your credit rating?

More and more of our young customers are talking to us about finance earlier, as they begin planning for making larger purchases in the future, like a new car, or buying a home. With real estate prices continuing to rise, their concern is making sure their credit score is as healthy as possible so they’ll be more likely to secure a loan down the years.

What is your credit score, and how is it calculated?

Your credit score, also known as your credit rating, is based on your financial history when it comes to credit, borrowing and repayments. It also takes into account how often you’ve applied for credit, and for what purpose. Lenders use your score as well as other risk-related criteria to determine whether to lend you money – how much, and what interest rate to charge.

Your credit score is calculated by credit reporting agencies, and can be represented in different numerical ways (sometimes between 0 – 1,200) but generally, the higher your score, the better. To reach this figure, reporting agencies examine:

• Your debt history, including any repayment issues you may have faced
• Loans and loan enquiries you’ve taken out to purchase, refinance or renovate houses
• Your current credit limit, as well as your credit cards and store cards
• Accounts you may have opened and/or closed
• Any history of default judgements or bankruptcy

What is the difference between a credit score, credit rating and credit report?

Firstly, your credit score and credit rating are the same thing - the two terms are interchangeable, and refer to the same thing.

Your credit score/rating is a number, usually between 300 to 850, which is assigned to you as a potential borrower. Your credit score/rating is an indicator to lenders and financial institutions which gives them an indication on the likelihood of you being a suitable candidate for a loan or credit product.

Your credit report is a sort of statement that details your history when it comes to credit products. It contains your loan and credit history, including information on how diligent you were in making timely repayments.

Which is more important?

In short, both. Your credit report is used to calculate your credit score/rating, and both are used by lenders and financial institutions when reviewing you as a suitable candidate for a loan or credit product. 

The way you have used credit in the past will be listed in your credit report, and this will be used to form the basis for your credit score.

It's important to note that there are other factors that may impact your credit score, such as time of calculation and calculation model, so different credit score providers may generate slightly differing scores in your name.

How do applications for credit affect my score?

Each time you make an application for credit, such as for a new credit card, your score will decrease slightly. If you’re a single card holder, and just want a better deal, or this is your first card, it’s not such a big issue, right? Your credit score will usually be pretty high anyway. Plus, after 12-24 months, the effect is reversed, as only recent applications are taken into account when calculating your score.

You may however see some negative effects when you’re making multiple applications for credit in a short period of time. Not only can this lower your credit score, but it may suggest a ‘desperation for credit’ to lenders, which almost always spells doom for new applications.

What Else Can Effect My Credit Score?

• Loan pre-approval: Generally speaking, getting pre-approval for a loan with a single lender is not considered to have any positive or negative impact on your credit score. However, applying for pre-approval with multiple lenders, particularly over a short period of time may impact your credit score negatively.
• Personal line of credit: A personal line of credit is like a revolving debt, so both your credit limit and repayment history will be taken into account when calculating your credit score. However, the most important thing to remember is that if you manage your line of credit properly, and meet your repayment requirements, this shouldn't impact your credit score negatively.
• Refinancing: While it's true that refinancing can affect your credit score, you'll be pleased to know that any drop in your score will usually be short-lived, and not major in scale. Once you begin making repayments on your new loan and demonstrate your ability to handle this credit properly, your score should return to previous levels.
• Withdrawing from my saving accounts: The good news is that savings account balances don't appear on your credit score - they are calculated purely on your historical ability to manage credit products. Any large or small withdrawals from your savings accounts should have no impact on your score.
• Overdraft: Whilst overdrafting on a checking account won't directly affect your credit score, it can indirectly cause an impact. As long as you pay any overdraft fees and negative balance back, you'll be fine. However - if you don't pay back what you owe, and the debt is sent to collections, this can appear on your credit report, which can then impact your score.

How to manage your credit score

Yes, it’s true that making applications for credit can lower your credit score, which is why you should avoid making new applications until you’ve done your research.

As well as this, maintaining a healthy relationship with your existing forms of credit will help – paying your bills on time, making all loan repayments and not spreading yourself too thin financially may seem basic, but it is vital when it comes to keeping your credit score high.

There are several free online services you can use to monitor your credit score, such as Credit Savvy.

If you’re in the market for a simple, low rate credit card, be sure to check out Greater Bank’s Visa Credit Card today.