When it comes to borrowing money, understanding the APR (Annual Percentage Rate) that you’ve been offered isn’t always as simple as it could be
From credit cards to loans to mortgages, there’s a huge amount of products and providers for you to choose from in the market, but there’s also a variety of factors that lenders will look at when they are considering whether to lend to you and at what rate.
By knowing the different things that lenders look at to determine your credit health and personalised rate, plus acknowledging where you can make improvements, you could save yourself a significant amount of money the next time you want to apply for a credit product.
An initial word of caution on credit scores
Your credit score is based on your credit history or a credit file. This is a record of your address details, all your previous financial transactions, plus if you have any credit cards or car loans, mobile phone deals or mortgages.
These records show what your financial commitments are and how well you’ve managed money in the past. The records are kept by the UK’s three credit reference agencies: Experian, Equifax and Transunion.
Lenders will use the information from the credit reference agencies to see the specific credit score of each potential customer. However, the score that the credit agency gives you is based on their own judgement of your file - it’s a guide, not a guarantee of how a lender will see you and doesn’t give a full representation of your financial situation.
Banks and lenders must also look at a whole range of ‘affordability indicators’ to determine your ability to keep up repayments on a specific loan. For example, at Zopa, we would never lend to someone if we weren’t convinced they could repay their loan without compromising on necessary spending or if we thought they might struggle to make repayments in the future.
Zopa now has a ‘Borrowing Power’ feature with a score from one to 10 to help customers get a clearer picture of their credit health, including credit score and tailored insights of how to improve if it needs a little TLC. It also shows exactly which Zopa loans and APRs a customer might be eligible for.
Demonstrating the ability to make repayments on your loan is a major part of what makes you attractive to lenders and helps to determine if they should or shouldn’t lend to you.
You should keep an eye on your credit score to make sure you’re improving it over time and ensure that you’re applying for a realistic amount of credit in terms of your financial situation, but there are many other things that you should consider that could improve your chances of accessing more affordable credit.
1. Register to vote
Make sure you’re on the electoral roll. Lenders use this alongside additional information to confirm your identity, check that you are who you say you are and as a proof point of stability.
It’s also worth noting that you’re less likely to be accepted for a loan if your address on your credit history, or the address where you’re applying for a loan, doesn’t match the address where you are registered to vote.
2. Get on top of your debt
Being in lots of unmanageable debt, using payday loans or failing to pay bills on time can damage your credit score. Any missed payments stay on your record for up to six years.
If you use credit cards, you need to keep an eye on your credit use. If you have a credit card that has a limit of £1,000 and you spend the full £1,000 each month, your credit utilisation on that card would be 100%. The ideal amount you should spend is between 25% - 30% of the credit available to you across all products.
3. Avoiding a thin file is just as important
Lots of people think that they won’t be able to borrow money because they have too much debt, but there is such a thing as not having enough. This is known as having a “thin file”. It’s a bit of a chicken and egg situation - lenders want to see that you can handle debt well, but they can’t if you’ve never had any credit products before.
Typically, this affects people who have recently moved to the country or don’t have a utility bill in their name. Taking out a credit card, using it sensibly and repaying more than the minimum payment each month or setting up a direct debit for a utility bill will help boost your credit health.
4. Check your disposable income
There’s usually that period between paying all your bills and waiting for pay day where you have the least disposable income. If you don’t have a lot of money left during this period, lenders will be considering whether you can afford the loan or credit card repayments.
If you can adjust the amount you want to borrow or make any changes to your other monthly outgoings so you have a higher disposable income each month, this will help you paint a better picture of your affordability to lenders.
5. Don’t apply for too many products
Be careful about applying for too many financial products in a short space of time. Lenders may think twice about lending to you if you’ve applied for lots of different loans and have hard searches on your credit file – it may give the impression that you aren’t great at managing your money.
Some lenders will show you a personalised rate without marking your credit file – this is called a soft search. If you are shopping around, you should check to make sure that a provider only makes a soft search initially.
If your score isn’t in great shape, then you might want to avoid hard searches altogether for a while by holding off on making any new credit applications until your credit score is in better shape.
The aim is to make sure all lenders see the absolute best version of you before you ask to borrow money. While most people know that a poor credit score will result in being rejected for a loan or credit card, many don’t understand that it could end up costing you more money if you are accepted.
You want to give yourself the best shot possible at getting the cheapest credit that you can.
Didier Baclin is chief product officer at Zopa
The views expressed in this article are those of Zopa and do not necessarily reflect the opinions of Moneywise.
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