How your credit score affects the interest rates you pay

Watch out! Your credit score could soon affect the interest rate you pay. That’s good if you’re a “unicorn” with a credit score from 801 to 1,000, and not bad if you’re a “thoroughbred” with a score of 601 to 800.

If, however, you’re a credit “donkey” at the very bottom of the credit score pile, a credit pony at 201 to 400, or a farm horse from 401 to 600 you could well pay more.

Why “donkeys” pay more thanks to their credit score

That’s because Australia lenders will soon be adopting a new style of “risk-based pricing”. That means they offer different rates to customers depending on how bankable you are as a borrower. At the moment you’re offered the same rate whether you’re head and shoulders better than other borrowers or someone who has a pretty average record. Here’s what you need to know:

• It’s new. Risk-based pricing is new in Australia. In the past “negative” credit scoring only measured you on your defaults. As “positive credit reporting” becomes more common your payment history will be taken into account. The data enables lenders to make better judgements about whether we’re more likely to pay or default.
• Who’s offering it? Peer-to-peer lenders such as RateSetter and SocietyOne do this already, says Steve Brown, director of bureau engagement at illion, Credit Simple’s parent company. They rate you  from A-E according to your credit score. It’s very much the norm now globally for banks to price according to credit scores as well. We’re playing catch-up here in Australia. 
• Why do it? Risk-based pricing is starting to happen over the ditch in New Zealand. Lenders want to attract the best borrowers who they know will pay the loan back without being chased. By offering lower rates to the unicorns and thoroughbreds banks and other lenders reduce their risk. It’s also a marketing tool to attract better customers.
• What about mortgages? Sooner or later you’ll be offered mortgage rates based on your credit score, says Brown. It already happens informally. Banks are sometimes willing to knock a few points off their mortgage rates to gain or keep a good customer. Conversely, borrowers whose bills get in the way sometimes have to go to second tier lenders such as finance companies to get a mortgage at all. Typically the rates will be higher than banks offer.
• Wait, but my credit score sucks. As with mortgages, there is already an informal system that means borrowers pay more if they’re swimming in debt. Aussies with really poor credit scores may not be able to borrow from the bank or credit union at reasonable rates and be forced to go cap in hand to finance companies. For the very worst credit scores the only choice may be payday lenders that charge much higher interest rates.

Never fear. Credit Simple is here with some good advice even if you’ve sabotaged your own credit score. You can get yourself ready for risk -based interest rates by cleaning up your credit score now.

How to get better loan pricing

Start by checking your credit record by ordering your report from all four agencies: illion, Experian, Equifax, and the Tasmanian Collection Service. Go through your report with a fine tooth comb. If you think any entries are incorrect or unfair, contact the bank, finance company, or other credit provider such as utility companies  and ask for them to remove these.

The next step to cleaning your credit record is to pay off any debts that have led to defaults. Ask the credit provider to remove the default once you have.

Finally, start paying each and every bill on time including your rent if you’re a tenant. If you need to start budgeting, ensure this happens. Every single payment is a positive mark on your credit record and soon you’ll be moving out of donkey territory and becoming altogether more desirable to lenders.