An excellent credit score is one of the most priceless assets a potential home buyer can have. This tool has the power to secure favourable mortgage and refinancing rate, influencing everything from the size of the loan repayment to the interest rate on the home loan.
“It is advisable that potential home buyers check their credit score before even starting to look for homes or applying for a home loan, as the banks will look into your financial history and the application will be declined if you have a low credit score. The important thing is that your accounts are up to date and that you have the ability to afford the bond,” said Craig Hutchison, CEO Engel & Völkers Southern Africa.
South Africans are entitled to a free copy of their credit record every year.
“Many South Africans are surprisingly unaware of the importance of a good credit profile, many do not know what a credit profile even is, and even if they do, they seldom check their own personal credit profile. Today many potential employers look at credit profile reports as a way to judge a person’s character and level of responsibility,” said Mellony Ramalho, group executive African Bank.
Your credit score is typically a number from 0 to 999 and is calculated by using all the details on your credit profile. “It reflects a ‘score’ summary of all your financial decisions, it is often used by lenders, such as home loan and personal loan companies, to make accurate decisions on whether they should lend to you or not,” said Michael Bowren, CEO and founder Fincheck.
Overall, a credit score measures the amount of potential risk the consumer is to the creditor.
How does a credit score work?
The higher your score the better your credit health will be, which will be an advantage when applying for a home loan, making it easier for you to borrow money at lower interest rates.
“The lower the score, the higher the risk which then influences the outcome of the credit application,” advises Andile Fulane, CEO, Seed of Prosperity.
By managing your credit profile effectively, you can ensure your image and profile is viewed favorably by lenders or other organisations. A bad credit score would mean the exact opposite of this and result in almost no financial institution willing to offer you a home loan.
How do they calculate your credit score?
Your credit score is calculated by a credit bureau based on your credit report. They consider how you pay your bills, how much debt you have and more importantly, how all of that compares to other credit active consumers.
Each bureau has a different way of calculating your score and take into account different forms of information, including information their organization already holds on you, or your employment circumstances.
Your credit score is only one part of your credit report although it is almost the single most important item on your credit report; the full report gives you some handy information. Your credit report is a combined summary of your financial background with an overview of your credit score, financial accounts, profile, and rating.
What influences your credit score?
As you start transacting with various banks, retailers and other financial institutions like lenders, you start building a financial history. Your credit history will be determined by the amount of money you have borrowed in your life and how much of it you have diligently paid back on time.
Credit score is affected by the following:
- Missing payments or not paying on time, even if you make double payment the following month the score will affect your credit history. “While adverse legal information is cleared as soon as the account is settled, the negative repayment history however remains for a couple years,” said Ramalho.
- Too much debt – how much you owe and how much of your available credit you’re using – it is advisable to try to keep the use of your current credit facilities to less than 35% of your limit.
- Negative information like a court judgment taken against a consumer’s name (commonly known as blacklisting).
- Length of credit history.
- Account application and enquiry activity – within a short period of time, how many account applications the consumer submitted and how many new accounts you opened.
My credit score is lower than I expected. Why is this?
Fincheck provide some reasons:
- A credit history of fewer than 6 years, which is the time frame used to calculate your total credit score.
- Missed or late payments over the last 6 years.
- Holding very few credit accounts means there will be less credit history available on your profile.
- Court judgments or record of insolvency.
- Having a lot of unused credit available could lead to a large balance of debt if you decided to use it all at once.
- Balances on your accounts that are very close to the credit limit indicate that you rely on credit to get through each month.
Why improve your credit score?
Credit providers measure their risk in taking you on as a client before they approve or decline your application for credit, so improving your credit score increases the chances of being granted credit on favorable terms.
How to improve your credit score
- Regularly checking your credit report to confirm all the details are correct.
- Making sure you make payments on any outstanding credit accounts on the due date. (Should you have difficulty in making your payments, you should contact your credit provider to agree on a payment plan, or to reduce your regular payments to an amount that you can afford to pay).
- Consider setting up regular automated payments rather than doing manual payments.
- If you have too many old, unused credit accounts, consider closing them.
- If you are almost reaching your credit limit on one or more accounts, try and reduce your balance. Outstanding balances mean you have a lot of outstanding debt in your name.
How long does it take to improve your credit score?
It depends on how long it will take to improve areas that need attention and maintain them, real improvement will start showing after three months of consistency, as you show progress your credit score will automatically get updated.
If you have had a couple bad experiences with your credit health, it is helpful to know that, credit inquiries stay on your credit report for up to two years, whereas more serious activities that incur namely late payments, lawsuits, bankruptcy and tax liens will stay on your credit record for up to ten years.
How to build up a credit score if you don’t have debt
Unfortunately you won’t have a credit score if you don’t have any debt because your credit score is calculated and based on your credit habits. This doesn’t mean your financial health is bad, there’s just simply not enough data to give you a credit score.
This can be bad news if you’re looking for a home loan though, so your first steps will be to apply for financial products where you can start building a credit record.
These can include:
- Credit card
- Vehicle finance
- Phone contract
- Clothing accounts
Consequences of a bad credit score
Not paying your account on time or at all which can result in you not getting further or desired credit when needed.
Lenders will see you as a high risk meaning that should they decide to take on that risk, they will charge high interest rates compared to someone with a good credit score.
Depending on what industry you are in – some industries such as banking – check a potential employee’s credit report and score. They consider a bad credit score as someone who is not trustworthy to work in a banking environment.
Consequences of not checking one’s credit score
It is advisable for a consumer to check their credit report every 3 to 6 months. Statistics show that only 3% of the 24 million credit active South Africans have seen and understood their credit report.
This comes as a threat of potential identity theft where someone can use a consumer’s ID to clone their profile and open lines of credit. A credit report contains so much personal information including addresses, phone numbers and employment that the leak of such information poses a big risk of fraud to the individual.
How a credit score affects you when applying for a home loan
When it comes to taking out forms of credit like a home loan, your credit score plays a vital role in your eligibility for a home loan, however it’s not the only factor to affect your application, your debt-to-income ratio will also play a big role.
What score do you need to qualify for a home loan?
There’s no specific score which will qualify you, if you follow the step to build a healthy credit score and maintain a healthy debt-to-income ratio, lenders will see you as eligible for things like home loans. Most lenders prefer to lend to an individual whose debt is less than 36% of their gross income.
This, along with healthy credit habits that keep your score in the ranges above 650 will put you in a good position to secure a home loan.
If you are declined for a home loan, what should you do and when do you apply again?
It’s important to know that if you apply for any hard forms of credit like a personal loan, credit card or home loan, you will get a hard inquiry against your credit report, too many of these are a red flag to lenders.
If you have had an unsuccessful home loan application, take a step back and start improving your credit health. There’s no fixed time frame for this, it will take as long as you take to form healthier credit habits, pay back debt and wait for that very happy green indicator on your credit report.