How your credit score affects the interest rates you pay (and welcome to the brave new world of risk-based pricing)
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 New Zealand lenders are turning to a new style of “risk-based pricing”. That means they offer different rates to customers depending on how bankable you are as a borrower. Here’s what you need to know:
- It’s new. Risk-based pricing is new in New Zealand. In the past “negative” credit scoring only measured you on your defaults. The government changed the rules to allow “positive credit reporting” that takes into account your payment history. 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 Harmoney do this, says Steve Brown, director of bureau engagement at illion. If you want to borrow money from a peer-to-peer lender you’ll be rated from A-E according to your credit score. It’s very much the norm now globally for banks to price according to credit scores, We are just a little behind in this downunder. The Co-operative Bank was one of the first (if not the first) banks to offer risk-based pricing in New Zealand. It reduces interest rates, for example, if you have your main income paid into your everyday account. That makes it safer for the bank to lend to you.
- Why do it? 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. Likewise if they can see from the positive credit reporting data that you have an adverse credit history they can charge more. It’s only a matter of time before credit card interest rates are based on your credit score as well.
- 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 with less than sterling credit scores 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’ve had debt disasters in the past. Kiwis 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 exorbitant rates of interest.
Never fear. CreditSimple is here with some good advice even if you have 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 score right here on Credit Simple. You’ll also get some of your key credit history (just click on the ‘credit file’ tab once you’ve accessed your dashboard). Then get your full credit record by ordering your report from the three agencies illion, Centrix and Equifax. Remember that there’s always a free option – you don’t have to pay, you just need to wait a little bit longer. 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 no excuses budgeting to ensure this happens, do it. 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.
Francis is Credit Simple's resident content writer and social media guru. He's passionate about saving money, so we pay him 5 cents to go out and fetch the team coffees every morning. Thanks Frankie.All stories by: Francis Church