What is your credit score?
Finding your dream home is a pretty exhilarating feeling—if you have your finances sorted beforehand. If you’ve not yet gotten pre-approval, the feeling is going to be threaded with an anxiety-laden line of ‘OMG, what if the banks won’t give me a loan? What if I lose this house I’ve completely fallen in love with?’
If you’ve bought off plan, not knowing if you will get a loan feels more like ‘what if I lose this home into which I’ve invested all my time and emotional energy AND I lose my deposit?’
That’s why you need to understand what banks are looking for in home loan applications. And part of that is your credit score.
So what is that? How does it work? How do you find our what yours is?
Your score is an important tool that lenders use to assess the risk that you won’t meet your repayments. There are things you can do to improve it, and some lenders are more open to applicants with low scores than others.
We spoke with Mark Edlund, Managing Director of Clarity Home Loans, for more information on credit scores.
What is a credit score?
The term ‘credit score’ refers to two things at once.
- National credit score
- The bank’s own algorithm
Your credit score is a number between 0 and 1200. It is based on the information in your credit history and your previous financial behaviour. Credit reporting agencies calculate your financial information, which includes:
- The amount of credit you have borrowed
- The number of credit applications you have made
- Any unpaid or overdue loans
- Any defaults, debt agreements or bankruptcies.
The score tells lenders how responsible you are and whether you’re likely to repay the loan they give you, on time, each month. You become an increasingly safe bet the higher your number goes.
We always recommend looking at your credit score before applying to a bank—a mortgage broker can tell you what yours is. If you apply for a home loan and are turned down because of your credit score, it’s harder to get a loan in the future.
What impacts your credit score?
Your credit score is affected by a number of things, including your personal details, credit history and credit mix. Here are the top three things that might lower your score.
Making a lot of credit applications in a short space of time.
- Credit cards
- Personal loans
- Car loans
- Buy now pay later schemes (Afterpay and Zipay)
Each application for credit is recorded on your file. Too many applications can decrease your score. This is one of the reasons that you want to avoid using credit, particularly leading up to your loan. You also want to talk to a mortgage broker before doing something like applying for a personal loan to consolidate your credit cards. Sometimes that’s the right move. Sometimes it’s not.
Defaulting on your bills.
- If you are more than 60 days late on a payment of over $150, it’s registered as a default.
Habitual late payments.
- Payments less than 60 days late will show up on your internal file with the bank.
- They won’t be reflected in your credit score, but it will be taken into account by the bank’s algorithms.
Banks are sharing more information than ever before, so going to another lender might not solve this.
Be aware that banks aren’t limited to your conduct with them. The advent of comprehensive credit reporting (CCR) means they can see your entire credit history for the past two years, across all lenders. This includes late and on-time payments.
What's a good score?
The higher the score the better. There are five ranges from ‘below average’ to ‘excellent’. The ranges indicate how likely or unlikely it is that you will incur an adverse credit event, such as default, bankruptcy, or judgement, in the next 12 months.
833-1200: excellent. If your score is in this range, you’re in the top 20% of credit holders. Your odds of keeping a clean file are five times higher than average.
726-832: very good. Your score suggests that you’re twice as likely to keep a clean file as the average credit holder.
622-725: good. Your odds of keeping a clean file are slightly better than average.
510-621: average. It is less likely than average that you will keep a clean file.
0-509: below average. This score puts you in the bottom 20% of credit holders, making you a significant risk to lenders.
What score do I need to get a home loan?
There’s no easy answer to this. Your credit score is just part of the overall picture. The higher it is, the better, but lenders will still consider the other factors. A good credit score won’t overcome a lack of savings history or deposit. Some lenders are open to offering home loans to borrowers with bad credit, especially if there are extenuating circumstances.
It’s a balancing act for the banks. If you have a good deposit or great borrowing capacity, your credit score is less important. If it’s close to the line, it matters more.
There’s no definitive cut-off for a home loan. However, an average or below average score will raise red flags with lenders. In these cases, it’s wise to take some time to improve your score before making an application.
How can I improve my credit score?
Good financial behaviours over time can improve a bad credit score. Some simple things you can do include:
- Paying your bills on time
- Checking your direct debits to make sure that they’re set up for the right dates and you have enough money in your transaction account to cover them
- Making timely repayments on existing credit. If you can pay off your loans that’s even better.
What if I have a number of defaults?
Defaults stay on file for five years, and you might not want to wait that long. For a fee, you can pay a company who specialises in helping to remove defaults. They will look at how the default was applied. If there were errors in the original procedure, they can get the defaults removed for you.
In addition, some lenders will ignore a default if the debt was under $1,000 and has already been paid. This is common where the default was applied by a telecommunications provider.
Before you apply for a home loan, have a chat to a broker. They can tell you what your credit score is and what it means. If your score is lower than you want, they can find a lender who will work with you. We’ve written previously about the difference between a mortgage broker and a bank and what brokers actually do.
If you’ve got you eye on a particular one of our properties, chat to the agent, who can give you a recommendation for a good broker in your area.
*Independent is not a financial advisor. The information contained is for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before making any commitment of a legal or financial nature you should consider the appropriateness of the information having regard to your circumstances and needs and seek advice from a legal practitioner or financial or investment adviser.
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