Chicken for an Ox - The credit story!

I once had a customer ask me about why you lose points every time you try to obtain credit, and it got me thinking.

“why does that happen”, and “how can you recoup the credit points lost in a credit application?” This happens as lenders feel that you are risking something so as to obtain credit, and it could be said that the risk is whatever you are wishing to purchase using credit.

Let’s go into the way-back machine for a moment, in the old days, people used to barter a good in order to obtain another good. For instance, you could trade a chicken for an ox, that ox for a goat and that goat for a cow.

Nowadays, that bartering has moved on from precious metals (we still use those), to pieces of paper through to plastic and electronic transfers as well as treasury bonds and promissory notes – think bonds and promissory notes loosely as government IOUs to other governments.

Financial institutions get into this type of trading as well in the name of lending; they provide a certain sum of money to you at a given interest rate for a certain good. For example, you’re requiring credit (a home loan) to buy a house, and the bank giving you a 3.9% interest rate over a 30 year loan term, or you wanting to obtain a car loan instead of paying cash for it.

The bank, or any financial institution for that matter, can be there to provide it for you! In the home loan scenario, if you put a large deposit down as a percentage of the value of the property you want to purchase, the rate may be lower than if you were to put a small deposit down.

That phenomenon is known as “risk”, and how does a financial institution calculate risk? There are a multitude of factors, but let’s look at the main ones: the individual and the asset. Let’s say you’re 25, want to get a car loan and this is your first ever loan.

A lender would consider you more of a risk than, say, your parents’ as you haven’t obtained finance before and the lender doesn’t know your track record regarding this. As a result, your interest rate maybe higher than your parents’. I emphasise “may” here as no two lenders are the same.

Financial institutions also look at the asset. In other words, obtaining a car or personal loan has a higher interest rate than does buying a house. This is because car and personal loans are deemed “riskier” than a home loan as it could be said that you may be more willing to default on a car or personal loan than you are your home loan.

Did you know that even your telco (telecommunications company) and energy company look into your credit file if you apply for a phone plan?

It’s because, like financial institutions telcos and energy companies are providing a service to you on credit, and they want to know that you will pay the bill on time, otherwise you’ll have no power and you won’t be able to use your phone!

So, how does this tie into you losing points on your credit score? Well, it’s because the more times you apply for credit, the more a lender tends to believe that you require credit so as to live.

A financial institution could see that you have applied for 5 credit cards. 2 personal loans, a car and home loan and deem you more of a risk than someone that has only applied for a home loan as again, they believe that you require credit to live – a “credit junkie”, you could say.

The next question is “how could you recoup the points you lost”? Don’t apply for any form of credit for an amount of time – 6 months for instance – and pay your bills on time. If you follow those two points, all things being equal, you shouldn’t have too much of an issue obtaining credit in the future.

To finish off, be careful and judicious when applying for credit, as you may pay for it in the long run.

Looking at financing a car, truck or any other asset  ?

With over 50 lenders on our panel, there is no doubt we can find a solution for your needs.

Contact Bianca  on 1300 471 767 or bianca.wilson@stratton.com.au  for a free no obligation chat.