Why it’s so important to keep a healthy credit record
No credit history means no credit score
Every transaction you make that involves borrowing money from an institution is kept on record.
How many times have you applied for a credit account and were turned down? When this happens, a lot of the time it is due to you having a less than desirable credit record.
This credit record is summarised in a single figure called a credit score. What is this credit score and how does it affect your credit applications?
To help understand a credit score, think of it as rating how good or bad a restaurant is. The higher the rating that other people give a restaurant, the more likely you are to eat there. And so, restaurants with bad ratings will have a smaller number of customers over time. As the good restaurants generate a track record of good ratings, they can charge higher prices in time because their quality would justify it.
This analogy can be applied to credit scores. Every transaction you make that involves borrowing money from an institution is kept on record. If you are diligent in paying your debts and you keep them to a manageable size, you improve your credit score (the higher the score, the better).
This score is accessible to financial and other service providers and it gives them an idea of your behaviour as a consumer of credit. The longer your good record is kept, the more favourable your profile appears. Your credit score is also compared to those of other consumers, just as we also compare the ratings of restaurants against one another.
Your credit score is generally used for two purposes:
- The first is that it tells potential creditors about the likelihood that you will pay them back what you borrow. If your score is lower than what they are comfortable with, your credit application may be rejected.
- Secondly, creditors use your credit score to determine the interest rate that they will charge you on your credit and loan accounts. A higher score means lower risk and will therefore mean paying relatively lower interest rates.
Credit scores are determined through a combination of factors. These will include:
- History of credit record: The longer your credit history, the better. This is because a long history provides a better picture of your repayment ability.
- Size of credit balance: If you have store accounts and credit cards, try to keep the amount outstanding at no more than 50% month-on-month. This means if your credit card limit is R10,000, ensure that your use does not regularly exceed R5,000. This will show that you are managing your debts well and are not overly dependent on them.
- Number of credit accounts: Having many credit accounts communicates to potential creditors that you are in a debt cycle, using one account to pay another. While you want to limit the number of credit accounts, the best-case scenario is not necessarily to have zero accounts.
People who have no credit history will also have no credit score. While this can be positive (due to having no debt to your name), there are also compelling reasons to actively maintain a healthy credit score. The biggest one is that, without a credit history, it is almost impossible to qualify for a home or car loan. Given the usually significant monthly repayments and long payment terms, credit providers will often require a credit history and a certain minimum credit score before accepting your application.
South Africans can get one free credit report every year. Make use of this no-obligation service to monitor your financial health. Your credit report will also allow you to pick up if someone has fraudulently used your information to apply for credit accounts.
*Siwundla holds the Financial Manager Risk qualification and is the investor relations and product analyst at CoreShares