How your credit rating affects the cost of borrowing

Money Advice Service

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 credit agreements on time, and also other bills such as gas and electricity bills and mobile phone contracts
  • 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
  • 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’ll 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.

Check our top tips on How to improve your credit rating

How your credit rating 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 might put up the interest rate for all the people in that group.

So even if you’ve been a good customer and always paid on time, you could suddenly face a hike in rates. That’s why maintaining a good credit rating 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.

What credit card providers must do

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

  • Not increase the interest rate if you have a debt problem – for example, if 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 the 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 of the increase.

Credit card companies have also agreed not to increase your interest rate within the first 12 months (as long as you don’t breach the account’s terms and conditions) and not to increase it more often than once every six months after that.

If you do choose 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?

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 website

How to repair your credit rating

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

This article is provided by the Money Advice Service.

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