When you apply for a loan, many lenders will base their decision on information they get from credit bureaus such as Experian and Equifax. This information is reflected in your credit score, and in general, a higher score will mean that:
You’ll find it easier to access credit
You’ll pay a lower interest rate
That’s not all there is to it though - in this article, we’ll look at how credit scores work, what score you might need to access various forms of credit, and what you can do if you want to improve your credit score.
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What are credit scores and how do they work?
When you apply for credit, the business lending you money wants to know whether you’re likely to be able to repay it. For example, they want to know whether you’ve taken out any loans before, and if you did, whether you paid them back on time.
Lenders don’t have this kind of information to hand, and that’s where credit bureaus come in. Credit bureaus gather information on all of us to build up a picture of each of our credit histories, and sell that information to potential lenders so that they can make better lending decisions.
When deciding whether to offer you a loan, there’s a good chance your lender will look at your credit report to decide whether you’re a good credit risk, and check that you meet their criteria.
If you want to know more about your credit report, you can contact credit bureaus directly, and most will also allow you to see a “score”, which reflects how creditworthy the bureau thinks you are.
People who move to the UK face a challenge when it comes to accessing credit. We wrote a guide on how new immigrants can build credit score to give you all the information you need to improve your odds.
How is a credit score calculated?
Each of the 3 credit bureaus in the UK have a different way of calculating a credit score, but a simple way to understand it is:
- You “gain” points for positive actions, such as paying off a loan in full
- You “lose” points for negative actions, such as defaulting on a loan
The different bureaus even use different scales, but will usually give you a number which translates into one of 5 rankings:
These ratings - and even the numbers that accompany them - are an estimate of eligibility rather than a precise number for you to rely on. Since different lenders have different criteria when they carry out a credit check, having a high credit rating doesn’t guarantee you will be accepted by every lender.
However, in general, the higher your score, the more likely you are to be able to access the best deals, across all types of loans.
What credit score do I need for a personal loan?
In practice, most people will be able to access some form of credit, regardless of their score. So there isn’t really a “minimum credit score” for personal loans in general, since there are so many lenders out there: from short term debt consolidation loans to longer term home improvement or car loans.
However, your credit score does determine how many options will be available to you.
A borrower with a very high credit score will have their pick of lenders, and will often be able to borrow at better interest rates. At the time of writing for example, the best personal loans currently have annual percentage rates as low as 2.8%. (1) However, that rate will be available only for certain loan amounts and to certain borrowers - most likely the ones with a very good credit history. Borrowers with fair credit scores will find it somewhat harder to access top deals.
Borrowers with poor credit histories will find it much harder to access most loan offers, and are likely to need to pay a higher interest rate. In extreme cases, the only options available to them might be products such as guarantor loans or payday loans (sometimes requiring a cosigner), which can be very expensive and result in high monthly payments.
Want to know more about different kinds of personal loans? We’ve also got a general guide to how personal loans work.
Related post: Wondering what documents you’ll need when applying for a personal loan? Our detailed guide has everything you need to know.
Why do lenders care about your credit score?
Lenders don’t care about the number specifically, but they do care about the underlying credit history, and a good credit score is a reflection of that.
They care about your things like your payment history because they want to make sure that they lend money to people who are likely to pay it back, and they think that borrowers with a good track record are more likely to be able to do that.
This applies to both secured and unsecured personal loans: your ability to make previous payments is how most lenders judge your creditworthiness.
However, your track record isn’t the only metric that’s important, and some lenders have new ways of assessing borrowers without relying on what a credit bureau says about you.
Are there any other options?
Yes. Your credit history gives a good overview of your past actions, but there’s a lot it doesn’t cover. For example, a credit report shows whether you’ve made loan repayments on credit card debt, doesn’t show your main income or expenditure on other things. And if you only arrived in the UK recently, or haven’t taken out a loan before, you won’t have built up a credit history yet, which can cause problems even if you’re not someone who would be seen as a bad credit risk.
So access to the best personal loans might not always depend on your credit score.
As a result, new lenders are using Open Banking technology to view this information in the personal loan application process and make credit decisions based on affordability, offering products like debt consolidation and personal loans in a straightforward way.
You might also consider other lenders such as credit unions, which are non-profit organisations and work differently to traditional financial institutions.
Lastly, it could be worth considering a credit card rather than a personal loan, depending on your circumstances (take a look at our guide to personal loans vs credit cards).
How can I improve my credit score?
If you want to improve your credit score, the best source of advice is the bureaus themselves. Equifax, Experian and TransUnion stress that the most important thing you can do is to pay off loans in full and on time and avoid missed payments. There is a little more to it though - here’s a summary of other tips they provide (2, 3):
+ Register on the electoral roll
- Use all your available credit (some lenders see high credit utilisation as a sign of financial stress)
+ Make monthly repayments in full over the loan term
- Borrow more than you can afford to repay
+ Only apply for credit you need
- Make numerous credit applications in a short space of time
A loan application might have an impact too, so we’ve put together a full guide to how a personal loan can affect your credit score.
Hopefully this article has dispelled some of the myths around credit scores and loan eligibility. But if there’s anything else you want to know, let us know in the comments below.
Now that you’ve read our article on personal loans, you might want to take a look at some of the options available to you. Our loan calculator is a great place to start.