How does Credit Score affect the Interest Rate on your Loan?

When you borrow money from any registered and reputable credit provider, your credit score works behind the scenes to determine the interest rate you'll get on your loan. Think of your credit score as a three-digit number that lets you know how many points you have won when you pay back your debts correctly. 

The more points you have, the more you can prove to lenders that you are worthy of receiving credit. Therefore, lenders will be more willing to offer you favourable rates on any loans you take out since you pose a lesser risk. This post dives into more detail on this topic by showing you how you can make your credit score work to your advantage.

South African lenders are more likely to offer you a lower interest rate if you have a higher credit score 

Loan providers use credit scores to make several decisions when approached by a client who needs a loan. Your credit score can be used to decide whether a bank or private loan provider should offer you credit, and at what terms. Generally, most lenders will look at the following factors in your credit report:

• Account activity history - This shows how long you have been borrowing money. A longer credit history that shows repayments being made on time means you have a higher credit score.

• The amount of money you owe - Lenders can see the size of your debt and whether you can handle it, depending on your monthly income. Registered credit providers in South Africa are required to practice responsible lending. This means you only get to borrow a loan amount that is limited to what you can afford.

• Negative judgements - These are often mentioned in your credit report when you fail to pay back any debt. The good news is once you make the necessary payments, the negative information can be removed. This will automatically improve your credit score.

• Frequency of loan applications - Do you regularly depend on loan applications to keep your finances going? This can indicate a lack of responsibility when borrowing, and it lowers your creditworthiness.

If a bank or loan provider denies you credit after checking your credit score, they are supposed to tell you why. They should also supply you with the details of the credit reference they used. 

Your Credit Score can also determine the interest rate you get when you take out a loan. It is quite important when negotiating the interest rate on more significant credit items like vehicle finance or home loans. In such instances, a few percent difference can cost you a lot of money every month. For example an added 1% above the current interest rate for a R300 000 vehicle loan taken over 5 years, will cost you about R1 000 extra every month and a lot more over the lifetime of the loan.

Some loan providers operate based on what's called 'rate-for-risk' pricing. How this works is that the rate of interest you get is matched to your risk of not paying back in time or at all. If they consider you to be a higher risk, you will end up paying a lot more than someone who is considered lower risk. 

Finding your credit score

Based on the National Credit Act, every South African is entitled to a single free credit report once a year. You can approach any registered credit bureau such as TransUnion and Compuscan to get your free credit score. When you need a second credit check, you can contact the same bureaus, but this time you'll get charged a minimum service fee. 

It is possible to sign up for a service that will continually monitor your credit score and give you updates regularly. Several banks and companies offer this service for an affordable fee. Others do it for free as part of their financial products. 

It is essential always to monitor your credit score so that you can quickly spot any wrong information and correct errors. This will assist you in making more informed decisions when it comes to your credit-related decisions. 

Fix your credit score and negotiate better interest rates

• Pay your bills on time.

A significant chunk of your credit score is made up of your payment history. Even small delays can affect your credit score a lot. 

Late payments can lower your credit score, while more severe problems like court judgements and declaring bankruptcy can be considerable blows to it. They can stay in your credit history for several years. 

If you forget a lot, it is probably a good idea to diarize your payment dates or set reminders on your phone. Also, you can make sure that you always keep some money in your account to cover your bills. Nowadays, things are a lot more convenient since you can do all this through mobile banking platforms. Alternatively, allowing your lender to place a debit order on your account can guarantee that your repayments are on time.

• Don't borrow more than you can manage

One of the most contributing factors when it comes to your credit score is the amount you owe. The more you pay your outstanding balances, the more your score improves. 

Taking loans when you have to is not considered a problem. The crucial thing is to ensure that you pay back in time. You can do that easily if you maintain a loan amount that you can easily manage. When you always have less debt in your name, overall, it will work in favour of your credit score. 

• Be more careful when opening new credit accounts

It is general knowledge that people who open multiple credit accounts at once may be higher credit risks than those who don't. It is advisable not to open new accounts too often. The reason is that every time you open a new credit account, it triggers an inquiry.

Read more about improving your credit score here.

What to do if you think the information on your credit report is wrong

It sometimes happens that the information contained in your credit report file is wrong. In such instances, you can contact a credit reference agency and file your complaint. You should know, however, that you can't ask for information to be adjusted just because you don't want loan providers to see it. 

It is also possible to add extra details about your credit score. For example, you can supply information about a past debt that is now paid off. That is called a notice of correction, and it can help you to improve your credit score.

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This article is a guest post written by CompareLoans.co.za. They are a 100% free service that helps South Africans compare personal, vehicle and short term loans from 30+ lenders, including their fees, interest rates and estimated repayment amount.