What is a Credit Score and How is it Calculated?

What is a Credit Score and How is it Calculated?

Erin Delahunty - 13 Jul, 2021

Thinking of applying for a home loan? Then it’s worth looking up your credit score – your potential lenders certainly will.

So, what is this magic number that can determine if your application is successful and even impact the interest rate you’ll pay? Here’s a guide to everything you need to know.

What is a credit score?

Your credit score, in essence, tells a potential lender how likely you are to repay your loan – your creditworthiness.

It’s based on your credit history, called a credit report, which outlines, among other things, your previous and current loans and debts and whether or not you have paid them on time. 

There are three major credit reporting agencies that lenders use in Australia. They are Experian, Equifax and Illion.

Each has a slightly different way of calculating your credit score, expressed as a number between 1 and 1000, in the case of Experian and Illion or 1 in 1200 with Equifax, so you can receive different credit scores from different agencies. 

As your credit score is generated at a specific point in time, it will vary month-to-month, taking into account any changes in your financial circumstances. That’s good news if you have a low credit score, as you can work to improve it.

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On the other hand, if you have a good credit score, don’t rest on your laurels, as poor financial performance will see your score fall.

If you’re new to borrowing, don’t be surprised if you don’t have a credit score or a low credit score; there’s simply not enough data out there for bureaus to work out your creditworthiness. 

You can get your credit score quickly online using your name, address, date of birth and your driver’s licence number or passport number.

Why is my credit score important and what can it affect?

One of the first things lenders will do when you apply for a home loan is to check your credit score. 

A high credit score means you have a history of responsible borrowing, and therefore a lower risk of defaulting on your loan, making it more likely your loan application will be successful. 

A low credit score, on the other hand, may make a lender think twice before signing off on your loan. 

man and woman celebrating their new home after good credit score and home loan approval

Your credit score may also impact your interest rate. If you have a great credit score you have more bargaining power when shopping around for an interest rate. If your credit score is poor, however, your rate may be higher.

If you have a low credit score, there may also be restrictions on how much you can borrow outright, or you may be expected to come up with a larger deposit, or find a reliable guarantor, to reduce the lender’s risk.

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How is your credit score calculated?

Any credit provider only has data about your specific business with them.

Credit providers, therefore, send information to credit bureaus, who collate the information, including any publicly available data, such as court dealings, into a credit report. This gives a more accurate overall picture of your creditworthiness.

Each credit bureau then uses its own algorithm to translate that data into a credit score. 

While credit reports were once only based on “negative financial events”, the introduction of comprehensive credit reporting means credit providers also have to report good credit behaviour as well. 

Your credit report will show the following.

  • Your personal details, including your name, date of birth, employment history and how long you’ve been at your current address.
  • Details of your credit or loan products, including the credit provider, the type of product, the opening and closing dates of the account and your credit limit.
  • Your repayment history, including when repayments were due and how often you paid. 
  • Any missed payments and if these were subsequently paid.
  • If you’ve defaulted on a credit or loan product (not paid your debt). Some utility companies may also report defaults.
  • Details of the applications you’ve made for credit or a loan, including the number of applications, as well as the type and size of the credit or loan you requested.
  • Information about any court judgments, bankruptcy or personal insolvency.
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What factors go into my credit score?

Paying your mortgage, personal loans, credit and store cards, and buy-now-pay-later debts on time shows you’re responsible and take your commitments seriously and generally lead to a good or improved credit score. Failing to do so will certainly have a negative impact. 

If you’re struggling to pay your bills, contact your credit provider and get a payment plan in place.

You should also make sure your utility bills are paid on time, as some power, phone and gas companies will report a lack of payments, called defaults, to credit bureaus. 

Applying for a lot of credit in a short period of time can also be a red flag to credit bureaus, as it could be interpreted as credit stress – needing to find new sources of money because you aren’t managing your debt well. 

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A further factor is how much of your total credit you’re actually using. Credit bureaus look poorly on those who repeatedly max out their credit cards or maintain high balances, even if they are making regular repayments.

Having a decent gap between what you could spend (credit limit) and what you do spend (credit amount), is a good thing, so aim to pay more than the minimum. 

Mistakes do happen, so if your credit score seems lower than you’d expect, request a free credit report, normally available within a few days, and check for errors. Importantly, asking for your credit information doesn’t impact your credit score.

What is a good credit score?

While your credit score isn’t the only thing lenders will take into account when considering your home loan application, it’s a good indication of where you stand. 

In general terms, an “excellent” credit score means you’re highly unlikely to default on your loan in the next 12 months, when compared to the rest of Australian credit holders, making you a great loan candidate with access to the best terms and interest rates. 

A “very good” score, means you’re unlikely to default in the next year, meaning your chances of a loan are also very good. 

And a “good” score means you’re less likely to default than other Aussies, so lenders will still look at you favourably. 

family moving into new home

The main Australian credit bureaus use slightly different terminology, but scores fall into three score ranges.

Equifax (1-1200)

  • Good: 666-755
  • Very good: 756-840
  • Excellent: 841-1200

Illion (1-1000)

  • Good: 500-699
  • Great: 700-799
  • Excellent: 800-1000

Experian (1-1000)

  • Good: 625-699
  • Very good: 700-799
  • Excellent, 800-1000

Having a lower score doesn’t automatically cut you out of the property market, though. 

Major lenders have several ways to offset their risk, such as higher interest rates, larger deposits and asking for a guarantor and there are lenders in Australia that specialise in mortgages for people with poor credit history. And, of course, you can work to improve your credit score to boost your chances.

Words by Erin Delahunty

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