How A Credit Score Is Actually Calculated And How It Can Impact You

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For the uninitiated, credit scores are a mysterious beast. How do they actually work? How are they even calculated? And what do they even mean to the average person in Australia? If you're reading this scratching your head and going into a shame spiral because you don't know the answer to any of the above, you're not alone.

To help demystify the term, we've enlisted the help of our pals at MONEYME who can help folks find out what their credit score is—for free. We spoke to one of their experts to get the lowdown on what the heck a credit score is so you can go forth in this wild world equipped with the knowledge you need. Read on to find out what the experts had to say when we asked the questions most of us are usually too shy to ask.

What actually is a credit score and how does it work?
Your credit score is a number that essentially tells banks and lenders like us how likely you are to pay them back. You can think of your credit score as a risk rating. The lower your score, the riskier you seem as a borrower. On the other hand, if your credit score is high, it’s a sign that you have good financial habits and lending you money is less of a risky move.

What are some misconceptions about a credit score?

Myth 1. Not having any debt means you have a good credit score.
Having no credit history is not necessarily a good thing, as there is no record of you as a borrower and your repayment behaviour. If you have no credit history, credit reporting bodies (also called credit bureaus) will estimate your score based on people who are similar to you. Over time, as you build a credit history, your credit
score will reflect your own borrowing behaviours. This means, having a loan or a credit card may actually improve your score (if you stay on top of your repayments).

Myth 2. You only have one credit score.
False. There are three main credit reporting bodies in Australia, and they all use slightly different algorithms to calculate your credit score, which means you likely have three different scores.

Myth 3. Checking your score will hurt your score.
Not true. Checking your score with a credit reporting body or by using a free credit score tool such as MONEYME's won't impact your score in any way. If a lender does what is called a “hard credit check” when you apply for a credit product, however, this will show on your credit file. Making too many credit enquiries could hurt your credit score, as you can look a bit desperate for cash.

Credit reporting bodies have to give you access to your credit report for free once every three months. You can request your credit report and make sure that everything is correct. Or you could download the MONEYME app to check your score for free and see what’s on your credit file. There are no limitations on how many times you can check, and it won't impact your credit score. Plus, you’ll be able to see how your score moves up or down over time. If you spot any errors, dispute them.

How is a credit score calculated?
Credit reporting bodies in Australia gather information about your financial habits from banks,
lenders and even your electricity and phone plan providers. For example, if you’ve taken out a
credit card, how frequently you’ve applied for credit, and whether you’ve paid your bills on time. Experian is one of the three main credit reporting bodies and according to them, each credit bureau uses a slightly different algorithm and exactly how that algorithm works is not disclosed. But what's true for all is that the higher your score, the better. Experian credit scores range from a 0–1000 and if your score is above 800 you've got an excellent score, whereas a score below 549 is seen as a poor score. 

What can people do to improve their credit scores?

1. Pay bills on time.
If your telco and utility bills (like electricity, gas and water) are more than
$150 and 60 days overdue, a default could be listed on your credit report and stay on your
report for five years.

2. Pay your credit card and loan repayments on time.
This demonstrates that you are a reliable borrower, and over time, this will have a positive impact on your score. On the other hand, overdue repayments will show on your credit history.

3. Don’t apply for too many credit products.
Each time you apply for a credit product, it becomes a ‘hard enquiry’ on your credit file. Making too many hard enquiries in a short space of time signals to lenders that could be a little desperate for cash or financially irresponsible. 

4. Check your credit report for errors.
Credit reporting bodies have to give you access to your credit report for free once every three months. You can request your credit report and make sure that everything is correct. If you spot any errors, dispute them.

5. Keep a credit card (if you use it wisely)
As above, having a good credit history can be better than having no history

Why should people care about their credit score?
With most lenders, when you apply for a loan or another form of credit, your score is used to determine whether or not or not they will lend you money, how much money to lend you and what type of interest rate or fees will apply to your loan. So, if you have a good score, it will increase your chances of getting your loan approved—and you might also be offered a better interest rate and a higher borrowing limit.

Do you need to have a credit card to get a credit score?
No. Even if you have no credit history, you will have a credit score, but it will be based on similar
people to you rather than your own good (or bad) credit behaviour.

Want to find out what your credit score is? Download MONEYME's app (just search for MONEYME in the App Store or Google Play) and find out in seconds using its free credit score tool here

Editor’s note: this article was produced in partnership with MONEYME. Thank you for supporting the partners who make Urban List possible. To read our editorial policy, click here.

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