How does your credit score affect a loan application?

When applying for a business loan, lenders will look at credit scores to assess whether you are eligible for a loan and will gauge this on how high or low your score is.

Credit scores are often used as an indication of how you manage your credit agreements and whether you can afford more credit.

Lenders use your credit score in part to assess whether you are within their predefined affordability criteria and regulations set by the financial conduct authority (FCA).

The FCA has set responsible lending guidelines to minimise irresponsible lending within the market. FCA regulations became more focused on affordability after the last UK recession in 2012. Before this, lending criteria was more relaxed in terms of affordability assessments, which resulted in high amounts of “bad debt”, where borrowers were unable to repay their loans.

With increased focus on affordability assessments, lenders now look to credit scores and financial behaviour when assessing a loan application.

There are a whole host of lenders who specialise in good or bad credit business loans and knowing what your credit score is can help you determine which lender to approach.

The type of loan you are applying for will also determine how much emphasis a lender will put on your credit score. With unsecured finance, there will be more emphasis on your credit score as you are not using assets as security.

You may have noticed when checking your credit score, that it can vary between reporting agencies. This is because there are a whole host of factors that make up your overall score and different reporting agencies can rate these factors in varying levels of importance.

All reporting agencies look at the same key factors;

• Debt Usage
• Repayment Behaviour
• Searches/Applications
• Age of Accounts
• Debt-To-Income Ratio

Debt usage, sometimes referred to as credit usage, is the amount of your available credit you are using.

E.g. You have a credit card with a £10,000 limit and an overdraft of £30,000, giving you a total credit limit of £40,000.

You have spent £7,500 on your credit card and are £1,000 overdrawn totalling £8,500.

To work out your debt usage, divide your total usage by your total credit limit and then times by 100.

(£8,500 /£40,000) x 100 = 21%

If you are using over 80% of your available credit, then this will have a negative impact as many lenders will see you as a higher risk than those with low debt usage.

Credit reference agencies and lenders can see high credit usage as an indication that you are not on top of your spending and borrowing and this can negatively impact your score.

How you have kept to your credit agreements has a massive impact on your overall score.

Lenders will look at your repayment behaviour over the past 6 years. Any late/missed payments or defaults within this time scale will have a negative impact as you have not honoured your part of the credit agreement.

If you have kept to your agreement and made all payments on time, then this will have a positive impact on your overall score.

There are two types of searches carried out by lenders when you apply for credit or a loan, hard and soft.

Hard searches are full credit checks and will be filed on your credit history as an application for credit/loan, regardless of whether you take out the agreement or not.

Soft searches calculate the likelihood of acceptance, however they are not guaranteed to result in a loan agreement even if you are shown as likely to be accepted, as this is based on the results of a full “hard” credit check.

Unlike hard searches, soft searches do not impact on your credit score. Soft searches are a good way for borrowers to find out their eligibility without carrying out a full credit search.

Having large numbers of hard searches on your credit file in a short period of time can reduce your overall score as it implies that you are “credit hungry”.

In addition, if you have many declines then this can be seen as a negative for many lenders.

When calculating credit scores, credit agencies and lenders try to assess if you are a responsible customer in terms of reliability, debt management and payment history.

If you have credit agreements that have been running for a long period of time it is easier to them to assess your behaviour.

If a borrower has few credit agreements or those that have only been in place for a short period of time, then it is harder to assess your behaviour and therefore credit worthiness.

Generally, long running credit agreements can increase your overall score if you have kept to the agreement.

In addition to your credit score, lenders will look at your debt-to-income ratio. This ratio will help them to further assess loan affordability. Your debt-to-income ratio is basically your level of debt in comparison to income.

All lenders will have differences in what they are willing to consider and approve when it comes to your ratio. What an acceptable level is, will be influenced by the lender and loan purpose.

To work out your debt-to-income ratio, firstly you will need work out your regular monthly debt repayments. These include things such as;

• Loan repayments
• Leases- HP/contract hire
• Credit cards
• Mortgages

Secondly, you will need to work out your monthly gross income before tax.

Your ratio is then calculated by: Debt Repayments / Gross Income

E.g. Debt Repayment = £5,000

Gross Income = £15,000

£5,000 / £15,000 = 0.33 or 33%

This may sound like catch 22, but one of the quickest ways to improve your credit score is by taking out more credit and making your repayments on time, as per your agreements.

To get more credit, stop applying, try to pay off any outstanding debts on time and start reapplying 6 months after your last business loan rejection.

As mentioned, repayment behaviour is extremely important to lenders as they want customers who sticks to their agreement by paying on time and in full. It is worth checking your credit report to see if your repayment data is accurate. If you notice any errors, then contact the credit provider who may be able to update your file if there are mistakes.