Credit rating or credit score is one of those financial terms which is often bandied about, but not necessarily understood, so what is it and why is it important?
At its most basic level a credit rating is an estimate of a person or organisation’s ability to repay money they have borrowed based on their previous payment history.
Credit bureaus calculate credit scores. They gather the information about your credit habits directly from your creditors as well as from public records such as court judgements. The scales they use can differ between bureaus, but usually include a descriptor indicating if you are very high, high, medium, low or minimum risk.
Although the terms rating and score are often used interchangeably, traditionally credit ratings applied to businesses and governments, while credit scores apply to individuals.
This strict definition has since shifted. One of the reasons is that although South Africans were entitled by law to one free credit report each year from any of the credit bureaus, most people didn’t bother to find out their credit score. This could be because they were unaware, it was too complicated to request a report, or it was difficult to understand.
As a result, some financial services companies, launched products such as DirectAxis Pulse which allow registered users to check their credit profiles as often as they like for free. Pulse provides ratings such as poor, getting there, good, very good or excellent rather than an actual credit score, simply because the terms are easier to understand.
It also offers additional information such as your monthly credit commitments and a breakdown of transactions that affect the score. Users can also track their rating over time.
Whatever it’s called, what’s important to remember is that a high credit score or good rating indicates that the person wanting to borrow money has a good track record and is likely to pay it back within the agreed time. A low score suggests that the borrower has had trouble with making payments in the past and might have similar problems in future.
The reason credit scores are important is that these help credit providers to decide whether they should lend someone money. Your score can also affect the interest rate charged on a loan.
A person with a low credit score will be considered high risk and as a result may not be given a loan as their score indicates that they may not be able to afford to pay the loan back.