What do lenders mean by a good credit score?

When you first embark on home ownership or property investment you often come across a variety of unfamiliar terms. 

There are loan-to-value ratios, unconditional contracts and credit scores to learn about.

In this article, however, we're going to focus on what is a good credit score in Australia, because many people don't consider this prior to it becoming an important factor in their future property dreams.

We'll outline what a VedaScore is and why it matters to your financial future, what is considered to be a good credit score, how it's calculated and how you can make it better.

So, what is VedaScore?  

When you first apply for a home or property investment loan, or a personal loan, there are a large number of financial checks and balances that will be assessed by your lender of choice.

Of course, using a qualified and professional mortgage broker, will ensure that you have the best chance of having your finance application approved but it's also important to understand how that approval process works.

First up, Australian lenders generally use your VedaScore as one of the ways that they calculate what your credit score is.

A VedaScore is calculated by Veda, which is Australia’s largest credit bureau.

Your score helps lenders assess your credit application when you apply for a loan or line of credit.

Similar to a tool that ranks your risk, all credit information is used to predict the outcome of your loan within the next 12 months.

It's equally important to recognise that in addition to your VedaScore, lenders will apply their own lending criteria.

That's why you shouldn’t completely rely on your VedaScore as an indicator of whether you can apply for the credit or not.

Most people don't understand that the way that operate financially could ultimately impact their credit score.

That is, if you regularly miss your credit card payments or are always overdue paying your monthly phone bills, then this can have a negative impact on your credit score.

What is considered a good credit score?

One of the benefits of understanding your credit score is that there are specific guidelines about what constitutes a good score.

It's fairly straight forward that the higher your credit score the better, because your credit score affects your access to better loan and credit card deals.

While your VedaScore is but one facility that lenders use to assess your finance application, they do provide succinct information about the various score levels and what your credit score means.

Your VedaScore is displayed as a number and indicates the likelihood of an "adverse event" being recorded on your credit file in the next 12 months.

An adverse event can be a range of "bad credit" listings such as a default, a bankruptcy or a court judgment.

So, with this in mind, the higher your VedaScore, the less likely it is that an adverse event will be recorded on your file and the less of a risk you will appear to lenders.

The lower your credit score, conversely, the riskier you will appear as a borrower.

• Below average to average (0-509)It's more likely an adverse event will be recorded on your file in the next 12 months. You are in the bottom 20 per cent of Veda's credit-active population.
• Average (510-621) This score suggests that it's likely that you will incur an adverse event in the next 12 months. Your score places you in the bottom 21 to 40 per cent of the credit-active population.
• Good (622-725) Adverse events are less likely to be recorded for the next 12 months. You fall in the mid-range (41 to 60 per cent) of Veda's credit-active population.
• Very good (726-832) Unfavourable events are unlikely to be recorded onto your credit file within the next 12 months. Your score places you in the second-highest percentile range of the credit-active population (61 to 80 per cent).
• Excellent (833-1200) Adverse events are highly unlikely to happen within the next 12 months when compared to the average Australian. The odds of no adverse events occurring on your credit file in the next 12 months are five times better than the population average and you are in the top percentile range (81 to 100 per cent).

OK, I understand, but how are credit scores actually calculated?

The thing about credit scores is that they're not calculated by someone sitting there will be a calculator or an abacus assessing your latest bank statement or credit card transactions!

The wonders of modern technology means that credit scores are calculated by an algorithm that uses information from your credit file.

What this means is that your credit score is generated by looking at patterns in your credit history, characteristics of your credit profile, and aspects of your credit applications.

There are a number of variables that are considered during the calculation of your credit score.

These can include:

• One of the biggest impacts on your credit score can be numerous applications to different credit providers within a short period, so if you're "shopping around" for credit. This will increase the number of credit enquiries on your credit file and is less favourable than having infrequent and fewer credit enquiries.
• The spread of credit enquiries over time can influence your credit score. Older credit enquiries have a different level of risk associated with them than more recent credit enquiries. That's why it's so important to keep your credit enquiries to an absolute minimum. 
• Of course, negative information such as defaults, serious credit infringements, bankruptcies, and court judgements are high risk indicators and can also adversely impact your credit score.
• There are a number of other potential risks, which are derived from your personal details, which can include your age, length of employment as well as length of time at your current address. Credit assessors generally like to see stability of employment and in your living situation, which both can improve your credit score.
• The age of your credit history can also impact your credit score, so a credit file with a longer credit history will have a different level of risk than a newer file with a limited credit history.
• As we've discussed before, it can be more difficult for business owners to have credit applications approved. When calculating your credit score as a business owner, variables such as the location of your business, the length of time your business has operated at its current address, and the credit history information contained in the commercial section of your report may be considered.

What can I do to make my credit score better?

While it might seem that your financial health is assessed behind closed doors and you can't do anything about the result, there are a number of ways that you can improve your credit score.

The number one thing that you can do to make your credit scores better is one of the most simple – seemingly.

Whether you're in the market for credit or not, you should always pay your bills on time!

No excuses!

This includes credit cards or loan repayments.

We know it can be tricky to keep up with these, but online banking these days makes it much easier to never miss a bill payment by setting up reminders or scheduled payments.

That way you should never miss a payment – even if you're on holiday at the time!

We always recommend paying off credit card balances in full in every month, but when it comes to your credit score it's not the balance that's the most important, it's the credit card limit.

So, as well as paying off the balance monthly, consider lowering the limit from, say, $15,000 to $5,000 because it will be the limit that will be used in your credit score calculation rather than the balance.

Of course, this is even more critical if you have more than one credit card because all of the limits across the cards will be included in the calculation of your credit score.

In fact, it's a better policy to axe any credit cards that you don't use or are just there for a "rainy day" because that will likely have a favourable impact on your credit score.

Also if don't have a credit card (which isn't necessarily a bad thing) you should consider getting one – as long as you can pay off the balance every month.

You see, the thing is, your credit score is partly assessed on your ability to manage debt such as a credit card or a personal loan, so it's important that you can show that you're responsible and can pay off debt promptly.

About Andrew Mirams Andrew is a leading finance specialist who holds a Diploma of Financial Planning (Financial Services). With over 32 years of experience in finance, Andrew has been acknowledged by the mortgage industry with multiple awards. Visit IntuitiveFinance.Com.Au