A credit score determines your creditworthiness. When you apply for products like credit cards, loans, or mortgages, lenders check your credit score and profile to review your loan repayment history, credit utilisation, credit mix, and enquiries before determining your loan eligibility and terms. A poor credit score could lead to application rejection or approval with exorbitantly higher interest rates and unfavourable loan terms.
Credit Karma estimated that borrowing with a poor credit score could cost an additional £272,302 in interest payments over one's lifetime. These payments include mortgages, unsecured personal/auto loans, and credit cards. The amount has doubled since 2020 when the estimated lifetime interest amount for poor credit score borrowers was £129,073. The analysis found that elevated mortgage rates account for the largest extra cost for people with poor credit ratings, around £163,197. The situation is more grim for younger people. A 20-year-old with a bad credit score could accumulate £551,787 in interest payments by 68 if the credit score doesn't improve. It hardly makes sense to lose half a million pounds to interest payments when one in three working families or 11.2 million people in Britain don't have "rainy day" savings of at least £1,000.
More People Could Slip Into The "Poor Credit Score" Bucket
UK credit card debt balances have consistently increased to £70.31 billion in March 2024 from £55.79 billion in March 2021. Factors like more accessible credit products, high living costs, volatile job markets, and muted wage growth over the years have likely contributed to the upward debt trend. The financial difficulties across UK households are evidenced by the higher use of credit cards despite interest rates rising steeply since early 2023. The average UK credit card annual percentage rate (APR) jumped to a whopping 35.49% in July 2024 from 30.46% in January 2023.
Growing reliance on credit cards and emerging buy-now-pay-later apps for purchasing essentials could reveal signs of a deeper problem. The Bank of England's (BoE) record monetary tightening campaign, including 14 consecutive rate hikes since December 2021, has pushed borrowing costs to record levels, creating a recipe for unprecedented defaults on mortgages and other credit products. A recent BoE survey highlighted that Britain's top lenders expect a steep rise in default on unsecured debt as UK mortgages in arrears reached a seven-year high in Q4 2023 to reverse a long-term decline in overdue payments. An analysis from Fuse also estimated that high-street lenders are accounting for an expected credit loss provision of £760 million in 2024, up from £625 million in the preceding year as mortgage defaults surge.
Records of defaults stay in credit reports for years and bring down your credit score significantly in a short span. Missed payments often raise questions about your capability to repay outstanding debt on time. Mounting financial pressure on UK households and subsequent defaults are pushing more people into the debt-interest traps, with more outstanding balances slipping into delinquencies.
How To Improve Your Credit Score When In Debt?
Timely payments, moderate credit utilisation, a healthy credit mix, and low product inquiries help increase credit scores. If you fall behind on your credit card and mortgage payments or are stuck in the monthly minimum payment cycle, one way to lower your debt and interest payments is to free up cash flow. Borrowers can use the extra cash to make bigger repayments, considerably reducing interest payments and loan durations.
Unsecured loans, such as credit cards or personal debt, often carry higher rates, which means higher interest payments on outstanding balances. Prioritising the highest-interest debt by making the maximum possible payments towards it while making the minimums for the rest reduces your debt burden fast while saving you on interest payments. This is called the Avalanche method. Once you clear the targeted debt, move on to the next highest-interest-rate loan and follow the same process to lower your credit utilisation and boost your credit score. One can also opt for a balance transfer card to move high-interest balances to a new card bearing a lower rate. Often, lenders charge a balance transfer fee but provide 0% introductory offers for a year or more, offering an opportunity window to pay down the debt principle without interest accrual.
Another way to temporarily free up cash is to switch to an interest-only mortgage, where you only pay the interest on your mortgage principle. This strategy could offer breathing space, but you are not repaying the borrowed amount. Hence, it could be a short-term solution to keep monthly payments affordable until you can resume regular payments.
Showcasing your efforts to save and efficiently manage money can boost your credit score. For instance, credit builder programs report your money-saving efforts to credit bureaus like TransUnion and Equifax, who formulate your credit score based on several FICO models, with FICO 8 being the most popular. These programs allow you to save a fixed amount of money at a pre-set interest rate in a separate account for a particular duration. It is lending money to yourself. The service provider reports your monthly on-time contributions to credit bureaus that positively impact your overall profile. The credit builder service provider repays the principal about and potentially a part of the interest payments you made. Free online credit score checkers like Credit Sesame have a market edge with credit builder schemes that report your daily purchases like groceries and utilities on a debit to credit agencies. This way, the patented program eliminates any concept of debt or interest rates by boosting your credit score based on debit card purchases.
