When you apply for a home loan, there are two key things that lenders will consider when assessing your eligibility: Your debt-to-income ratio and your credit score. If you have a sub-par credit score, it will hinder your ability to get financing. That said, fixing a low credit score is absolutely possible.
But first, you need to understand how it works and what factors contributed to your low score (e.g. including late payments, limited credit history, and more).
With a little effort, you can get your credit score back on track.
So, let's get into it!
What is a credit score?
Your credit score is like a report card for your financial health.
Lenders use your score to evaluate your creditworthiness and determine if you're a good candidate for a loan.
Why is good credit important?
A good credit score is important especially when you're applying for bigger loans (like when you buy a car or house). But it also can affect you in other areas of your life like switching utility providers, rental applications, or attaining a business loan.
It shows the lender that you're a responsible borrower and will be likely to pay back the loan.
This benefits you because:
- Lenders are more likely to approve your loan.
- You may even be offered lower interest rates which will save money over the life of the loan.
How do lenders use a credit score?
When you apply for a loan, lenders need some way of assessing whether it's risky for them to approve your loan.
One way they do this is by looking at your credit score. It's a number that represents your creditworthiness — in other words, how likely you are to repay the loan.
In general, the higher your credit score, the less risky it is for them to lend you money. This means you're more likely to get your loan approved and be offered lower interest rates.
However, bear in mind that your credit score isn't the only thing that lenders look at when assessing your loan application. You'll also need to provide other information like your current employment status, level of income, or how long you've been living in your home. This allows them to get an overall picture of your financial health before making a decision on your application.
How is a credit score calculated?
Credit reporting agencies use various information about you in their credit file to calculate your personal credit score. This includes:
- Payment history: How prompt you've been with payments in the past for things like credit cards, utilities, and more.
- Past and current debts: Whether you've been repaying debts on time. They may also check if you've been bankrupt before.
- Loan history: They'll examine the kind of loans you have taken out before or been involved in as a guarantor. They might look at loan enquiries you've made in the past too.
- Type of credit accounts: What kinds of credit cards you've applied for, whether you've had problems making payments, and your credit limits will be assessed.
- Bank accounts you've opened or closed.
What is a good credit score?
The definition of a good score may be different depending on which credit scoring agency is doing the calculations.
In Australia, there are 3 main agencies: Experian, Equifax, and Illion. Each also has a different scoring system.
If your credit report shows scores out of 1,000, anything above 690 is excellent and above 540 is good.
For scores out of 1,200, anything above 800 is considered excellent while around 670 is good.
What is a bad credit score?
Again, what's considered a bad credit score depends on which assessment agency you use. But generally, scores between 300-500 are considered low.
If you're within this range, it might be difficult for you to borrow money from lenders or get approval for credit cards.
But not to worry. There are ways to correct a bad credit score.
First up, you have to know what got you into this situation.
Why do I have a bad credit score?
There are a number of reasons why you might have a poor credit rating.
Some of the most common causes may come from your own financial behaviours, such as:
- Missing repayments or making late payments on bills, credit cards, personal loans, or other debts.
- Defaulting on a loan.
- Having a high amount of debt relative to your income (this includes credit card debt).
- Having too many loan applications.
- Filing for bankruptcy.
However, errors can also be made by the credit reporting agency or a credit provider.
It's possible for an agency to have incorrect personal information, debt duplication, or incorrect amounts of debt recorded. So it's important to check all the details.
How can I fix a bad credit score?
Here's a step-by-step strategy for fixing a bad credit rating:
1. Know your score — Get your free credit report!
If you haven't already figured out your current credit score, go get your free report from one of the 3 credit reporting agencies. You're allowed to get your free copy every 3 months from each of them.
2. Check your report for errors
First up, make sure all of your personal details are correct (e.g. name and date of birth).
Next, you'll want to ensure the agency has all the right financial information. Things like duplicate debts or incorrect debt amounts do happen!
3. Fix your own financial habits and mistakes
Now, this is where things get a little more difficult.
If the root cause of your bad credit score comes from your own financial habits, you'll need to start making some changes.
Here are some of the best things you can do:
- Pay off any outstanding debts or late bills.
- Don't be late with making payments. Once you've cleared off any outstanding payments, ensure pay bills on time. Even one late payment can be damaging to your score. This includes utility and credit card bills.
- Keep your balances low. Having a high balance on your credit card can hurt your score, even if you always pay on time.
- Don’t open too many new accounts at the same time. Opening a lot of new accounts in a short period of time can make it seem like you're careless with the way you spend.
- Delay applications for new credit or loans in the meantime.
4. Start demonstrating your ability to handle loans well
Demonstrating that you're financially responsible doesn't mean you should have no loans at all.
Having "healthy debt" can actually improve your score. So keeping some credit cards and loans in your name can be helpful as long as you make your payments on time.
What if I find an error on my credit report?
If you find a legitimate error on your credit report, don't panic!
You can actually get these fixed for free.
These are some of the usual errors you might find, and they might have been made by the credit reporting agency or your credit provider:
Credit reporting body (or agency) errors
- Wrong name, date of birth, or address.
- Debt was listed too many times.
- Debt amount was recorded wrongly
If you spot these kinds of errors, simply contacting the credit reporting agency to fix it will do the trick.
Credit provider errors
- Incorrectly logged overdue payments.
- Failing to notify you about outstanding debts.
- Listing a default that's still in dispute.
- Report doesn't reflect changes in contract or payment plan terms
- Accounts created by mistake or due to identity theft.
To fix these kinds of errors, contact your credit provider and request for the mistakes to be corrected.
If there are no issues, they'll let the credit reporting agency know which details need to be fixed.
However, there are times when your credit provider might disagree with your suggested corrections. In this case, you can contact the Australian Financial Complaints Authority (AFCA) which offers free, independent dispute resolution.
If you're having any financial hardship and would like to speak to an independent professional, the government offers free and confidential financial counselling which you can learn more about on their Moneysmart website.
How long does it take to fix a bad credit score?
It's important to understand that repairing your credit is a long-term process, and there is no quick fix. It can take months or even years to see a significant improvement in your credit score.
This is because not all negative information on your credit report can be removed if it's true.
And even if you've changed some of your habits, certain things need to remain on your report for a few years. For example, things like home loan applications or defaults (even when paid off) will still be reflected in your report for 5 years.
But, by following the simple steps outlined above and staying patient, you can eventually get your credit back on track.
How can I check my credit report in Australia?
You can go directly to any of the 3 main credit reporting agencies to request a copy of your credit report for free. Reports can be requested for free every 3 months or if your credit application has been declined in the past 90 days.
Beware of credit repair services!
There are a lot of companies out there that promise to help you repair your credit. However, many of these companies are actually scams.
They may charge you for "quick fix" services that they don’t actually provide. Or, may give you false information that can further damage your credit score.
In some cases, these companies may even try to steal your identity. So, it’s important to be careful when you’re choosing a credit repair company.
Make sure you do your research and only work with a reputable company. Otherwise, you could end up worse off than you were before.
If you're ever unsure about a company, it's best to err on the side of caution.
You can always access free, independent, and confidential financial advice from not-for-profit organisations which are approved by the government.
