Almost everyone will, at some point, use credit – whether by borrowing money or paying a bill at the end of the month.
How does credit work?
'Credit' often involves borrowing money from a lender because you don’t have the savings to buy something straight away. But ‘credit’ can also include other situations like opening up a telephone account and paying the bill at the end of the month.
'Credit is any arrangement where you owe a ‘debt’ to a business and they agree to get paid sometime later.'
Life's big moments are often driven by the ability to get the credit you need, when you need it. How much you can borrow, and what interest rate you will pay, depends on your credit health.
Before giving you the loan or selling you something on credit, the business will want to make sure you’re likely to pay back the debt when you have to. If they don't think they'll get paid back, the credit provider won't lend you the money or sell you the goods or services on credit.
To help them make the decision, as part of the application process, the credit provider may ask you questions about your financial position e.g. how much you earn, how much you spend and what loans you currently have. This will help the credit provider work out whether you will be able to afford the new loan repayments.
But your income and expenses aren't the only things that the credit provider will look at.
What is a credit report?
A credit report is a detailed record of your credit history. Banks, credit card providers, store card issuers and other businesses that you have accounts with can list defaults on your report. Some credit providers, like banks, credit card providers and store card issues also list whether you’ve made your payments on time. This gives other credit providers an idea about how you manage loans and debts.
Credit reports only contain your financial data, not your personal details, medical history, criminal records, memberships and affiliations or ethnic background.
History has shown that even people who are in very similar financial positions (e.g. have roughly the same income and expenses) may have a very different likelihood of repaying money they owe.
Over the years, credit providers have worked out that the chances of someone repaying a new debt is strongly predicted by the way they have repaid previous debts. That's why credit providers use your credit report when trying to predict if you'll repay them what they're owed.
By being credit smart, you can make sure that the information on your credit report makes you look good. This will make it easier for you to borrow money or buy things on credit in the future. It may even reduce the interest that you have to pay when you borrow money.
What is on your credit report?
Your credit report is a record of your credit activity and credit history. It is prepared by a credit reporting body at your request, or at the request of a credit provider when you apply for credit.
Credit providers include lenders such as banks, credit unions and finance companies, and also businesses that sell you goods or services on credit like phone (home, mobile or internet) or utility (water, gas or electricity) providers.
At a minimum, your credit report will include information that is needed to identify you, such as your name, birth date, address and employer’s name.
It includes information about your credit history, such as:
- the types of loans and credit that you have applied for in the last 5 years, which is reflected as enquiries from credit providers who viewed your credit report with a credit reporting body
- a breakdown of the accounts that you’ve opened
- a 24-month breakdown of the way in which you pay accounts you have with banks, credit unions and other finance companies (but not phone or utility companies) - showing if you pay your accounts on time, every month
- whether you’ve ‘defaulted’ (i.e. missed your payments by at least 60 days) on any of your loans or credit accounts
- legal action against you such as a default judgment where a court has ordered you to repay money that you owe to a credit provider.
By law, your credit report can only be obtained by others in legally permitted circumstances. For example, your credit report can't be accessed by a real estate agent when you apply to rent a house, an insurer when you apply for car or home insurance or by a potential employer when you apply for a job.
Check out your credit scores
The credit report contains the "raw" data about your credit history. The report may be condensed by a credit reporting body or credit provider into a single number or ‘credit score’ which is used by a credit provider as an indicator of your credit health when assessing a loan application. Your credit score compares you to other borrowers and helps a credit provider decide who to lend to and how much to charge for interest – so it’s important to keep your credit score as high as you can.
The great news is some credit score companies will send you a free credit score every month. A monthly credit score shows you if the actions you have been taking to improve your credit score are working or not! By keeping track of your credit score, you can be confident that your credit health is in good shape for when you need credit in the future. If monthly looks too much, then an annual report is a good minimum to check.