Editor’s note: The following article contains information only. It is not intended as general or personal advice. Your Money recommends seeking professional advice specific to your personal circumstances.
When you apply for a loan or credit card, your credit score goes a long way to determining whether you’re successful.
With an excellent credit score, the financial world is your oyster. You’ll be able to borrow more money from a wider range of lenders – often at a better rate.
But if your credit score is bad, the reverse is also true.
Lenders will restrict the amount they’ll lend you and the products from which you can choose. In fact, if it’s very bad, you may not be able to secure finance at all.
So if you have a poor credit score, is there anything you can do to fix it?
“Yes,” says Leo Hillary from free credit score provider Credit Savvy.
“The good news is that you have never been more able to take control of your credit score and improve it. Once you know your score and see the information on your credit file that is driving it, you can identify what it is that you should focus on.”
How is your credit score worked out?
Your credit score is simply an attempt to measure how responsible you are with money.
There are three major credit rating agencies who hand out credit scores – Experian, Equifax and Illion (formerly Dun and Bradstreet).
Whether you know it or not, you’ll already have a mark out of 1,000 or 1,200 from each of them.
This mark will be based on your credit history. Traditionally, this has included your negative relationship with credit, including:
● How many times you’ve recently applied for loans or credit (although, as you’ll see below this can also be a positive)
● Whether you have any overdue debts
● Whether you’ve defaulted on any payments
● Whether you’ve recently been declared bankrupt, and
● Whether there are any financial judgments against you.
Since 1 July 2018, the Comprehensive Credit Reporting (CCR) reforms mean your credit score now takes into account your positive relationship with money too.
Each month, banks and other financial institutions will also share information on whether you’ve made repayments on time.
That means if you pay on time you’ll eventually see your credit score start to rise. Start missing payments and it will begin to fall.
“If you apply for a credit card, you’ll see your rating drop straight away. If you apply for a home loan and get approved, you’ll see it rise,” says David Scognamiglio, CEO of Credit Simple – an Illion-owned website that lets you see your credit score for free.
How to get a bad credit score
If you’re worried that forgetting to pay your credit card on time one month will lead to you being denied credit forever, don’t be.
“We should all pay our bills on time and if you miss a repayment on your credit card you’re likely to see your score drop around 50 points,” Scognamiglio says.
“On the other hand, if you default, you’ll see it drop right down to only about 150 out of 1,000. That’s hard to recover from.”
“It’s not unheard of for a lender to get it wrong and record a bad credit event against you”
Scognamiglio also cautions against getting too carried away with minor movements in our credit rating.
“If your rating is already excellent and it becomes a little bit more excellent, it won’t matter much. It’s when it’s low that you have to worry.”
“Intuitively, lenders will see about 650 as the cutoff. If you fall below that mark, it’s likely that you’ve had something like a default or a recent major negative event. You should take steps to remedy that as soon as you can.”
How credit scores get it wrong
And the first step you should take, according to Scognamiglio, is to make sure the information informing your credit score is accurate.
“It’s not unheard of for a lender to get it wrong and to record a bad credit event against you incorrectly.”
Sometimes, for instance, a creditor may record a debt that you’re disputing or that had nothing to do with you. Other times, they may have failed to tell you about the debt before reporting it to credit agencies.
If you notice this, immediately contact the creditor to alert them to the error. If they won’t, you can speak to the ombudsman in charge of their industry. They have the power to take it further and order it to be taken off your record.
The relevant ombudsman services include:
● Australian Financial Complaints Authority (AFCA)
● Telecommunications Industry Ombudsman (TIO)
● Energy and Water Ombudsman NSW
● Energy and Water Ombudsman Victoria
● Energy and Water Ombudsman Queensland
● Energy and Water Ombudsman WA
● Energy and Water Ombudsman SA
● Energy Ombudsman Tasmania
● ACT Civil and Administrative Tribunal
● Ombudsman NT
If you’re responsible for the debt
If you were responsible for the bad credit event, Scognamiglio says you should be proactive about trying to recover the situation.
This should include making any future repayments on time and holding off on applying for new credit. You should also address any current debts head on.
“Any outstanding debts on your record are really bad for your score and you should do what you can to settle them,” Scognamiglio advises.
“We are going down the path where people with better credit scores receive better interest rates”
“If you owe $1,000 and can’t afford to pay it, call the creditor and ask them whether they will let you settle the debt for $500. They will often be happy to accept something less than you owe. This will give you the chance to move on.”
But even once this is done, Fiona Guthrie, CEO of Financial Counselling Australia says that you need to be realistic about how long it will take to fix your credit score.
“If you have a legitimate default on your record, it will stay with you for five years,” says. “To recover fully, you will need to give it time.”
Taking extreme measures to repair your credit
Guthrie says the last thing you should generally do is to pay someone who promises to repair your credit score for a fee.
“If there is a legitimate default on your file, there is very little they can do and what you can do, you can do yourself,” she says. “They are likely to charge you a lot of money for little outcome.”
If your default is a symptom of problems with your finances, Guthrie suggests a better approach is to speak to a financial counsellor.
Financial counsellors offer a free service to people suffering financial stress and can advise you on how to address the underlying problem, as well as on a practical plan for getting back on track.
This includes advice on budgeting, consolidating debt and negotiating with a lender over financial hardship. In extreme cases, Guthrie says it may even include advice on how to declare bankruptcy.
“Bankruptcy should never be taken lightly but if the debt collectors are pursuing you it will make sure the phone calls stop and, after three years, it will give you the chance to make a fresh start.”
“If you’re up to your neck in debt and can’t repay, staying in that position is of no benefit to anyone.”
The future of credit scores
Finally, Gurthie says our credit score will only become more important as the banking system evolves and takes a more nuanced version of risk.
“The CCR will eventually see risk-based pricing become standard in Australia’s lending market. We are going down the US path where people with better credit scores receive better interest rates.”
Scognamiglio agrees and says that, when combined with open banking, positive credit reporting will eventually change the entire way we apply for loans.
“We’re not far away from the situation where a lender will be able to see exactly what risk you are based on the data that forms your credit score. When that happens you’ll no longer even have to apply and wait for an answer. You’ll immediately see who’ll lend you money, how much and at what rate.”
Credit Savvy’s Leo Hillary adds: “With the rollout of comprehensive credit reporting, Australians will have more capacity to demonstrate their credit worthiness simply by making their loan repayments on time each month.”
So, if your credit score doesn’t cut the grade, it’s time to start fixing it now.
Checklist to fix your credit score
If you find your credit score is below 650, there are some steps you should take to rectify it.
1. Know your score. Check your score with a reputable provider.
2. Make sure it’s accurate. Review every entry on your file to make sure it reflects reality.
3. Contact your creditor. If something doesn’t add up, speak directly to the creditor. If that fails, contact the relevant ombudsman.
4. Settle any debts. Outstanding debts are bad news for repairing a bad credit rating. Contact your creditor to settle any immediately.
5. Pay on time. Be sure to meet any ongoing repayments on time. Any missed repayments will stay on your credit report for two years.
6. Hold off applying for more credit. You’re not just likely to be rejected, you’re also likely to make your bad credit score even worse. Credit enquiries stay on your record for five years.
7. Speak to a counsellor. If you’re experiencing real financial hardship enlist the services of a free financial counsellor by calling 1800 007 007.
8. Give it time. After five years any defaults will disappear from your record and after just two years any missed repayments will be removed. Don’t be tempted to pay someone for shortcuts they can’t provide.