As someone who worked in and for Financial Services Companies for almost 20 years, and is an active investor (property and stock market) I have mastered how to maintain a good to an excellent credit score (see the end of this article) at all times. At racmacs.com, I coach entrepreneurs and business owners how to achieve the same – book a Money Management appointment with me at:
Credit Rating Definition
If you have tried to access some credit services such as loans or some services or products on credit, you may be familiar with the term credit rating. In case you are not familiar with it, credit rating refers to the evaluation of a borrower’s credit risk. It assesses the ability or likelihood of a borrower (or potential or prospective debtor) to pay back money borrowed.
Your credit score also dictates how you handed your personal or business financial affairs in the past and is used by suppliers/creditors and other companies to validate your creditworthiness.
Many people have a problem differentiating between credit rating and a credit score. A credit report or credit file is obtained from credit rating bureaus or agencies and is an analysis of a borrower’s history, financial commitments, repayment behaviour, and so on. It usually has a credit score that reflects the borrower’s source of income and repayment history. Lending institutions can then use the credit report as a credit rating tool, and asses the default risk vs the ability of the borrower to pay the loan. If the risk is too high, that is, the borrower is likely to default or does not have an existing or prospective income source to pay back, the institution is likely to decline, or may offer the credit at a very high interests’ rate to compensate for the risk. Credit scores mostly apply to individuals.
Financial services companies will usually have a credit rating from of the credit rating agencies such as Standards and Poor’s (S&P), Fitch Ratings or Moody’; these agencies provide a rating system to help investors determine the risk associated with investing in a specific company, investing instrument or market.
Ratings get assigned to short-term and long-term debt obligations issued by a government or a corporation including banks and insurance companies among others. Each agency has a different measure varying from AAA/Aaa for low-risk investments to CCC/Caa to C/D for high risk to junk/in default investments.
In a nutshell, credit rating refers to the creditworthiness of a borrower or the riskiness of an investment/debt provider. The borrower or debt provider may be an individual, a corporate body, a non-governmental organization or a government (a state).
This article is mostly focused on credit rating (or score) for you as an individual or for your business, and the effects or benefits of a good to excellent credit rating. It also mentions the disadvantages of a bad credit score, the importance of evaluation, the different institutions that use credit rating, as well as the different types of credit rating.
Why a credit rating is important
Considering all of the above, it is of great importance to have a good to excellent credit rating. The following are reasons why credit ratings are an essential part of a business and the economy as a whole.
- Credit ratings in general influence the lending rates – This affects both the borrower and the lender.
- Credit rating makes individuals and organisations involved in borrowing to practice a high level of faithfulness to keep an excellent credit rating- this reduces default cases.
- A credit rating report availed to investors help make solid decisions on whether to invest or not. A poor score may reflect an organisation’s inability to honour debts and make payments.
- Credit rating ensures that businesses or organisations create healthy business goals based on faithfulness, reliability and robust business policies.
- Credit rating rewards good credit records and punishes bad credit history and records.The entities and organisations listed are the primary users of Credit ratings below.
- Investors: investors use the credit reports issued by credit rating agencies to make informed business decisions. The reports help them to avoid risky investments by avoiding companies with poor ratings.
- Bankers and other lenders within a country: they use credit rating to assess the creditworthiness of potential or prospective borrowers. In this way, they avoid risky borrowers or adjust the loan interest rates accordingly, from the higher the risk, the higher the interest.
- Market issuers: credit rating helps in assessment in the stocks and bonds market (securities).
- Market regulators use the ratings.
- International organisations may use the ratings before deciding to extend some financial assistance to a company or country.
- Businesses wishing to gauge the faithfulness of potential business partners and clients, especially for significant projects or transactions.
Types of credit rating
The following are the different kinds of credit rating.
- Borrowers rating: this refers to the score of borrowers.
- Individuals rating is the rating of individuals’ creditworthiness.
- Commercial paper rating: this is used especially for short-term loans. The rating of papers issued by banks, companies and other financial institutions is called commercial paper rating.
- Rating of preference shares issued by companies.
- Rating of equity shares.
- Rating of debentures or bonds.
- Sovereign rating is the rating made on a state or country by assessing its creditworthiness.
- Insurer Financial Strength Rating is the rating of insurance firms or companies and their ability to pay the insured when required – this is great news for the insured, as an insurer with a good rating is more likely to settle claims.
- National ratings compare the ratings of service or financial issuers in a certain country- this helps the citizens in the country to make comparisons and make wise decisions.
- Rating of financial institutions: involves rating of long and short-term local currency as well as foreign currency, the rating of the institutions’ financial strength and the assessment of support ratings (support ratings are concerned with the evaluation of the chances that a bank will get external support when it experiences difficulties).
Benefits of good credit rating to the borrower
Maintaining a good credit score or rating is of great benefit to the borrower. As a borrower, here are some benefits of having a good to excellent credit rating:
- Makes it easy for you to access loans or credit when in need.
- Makes it easy for you to get investors to invest in your business if you require them. They will be able to access your credit rating report.
- You are likely to get better interest rates from lenders if you maintain a good to excellent rating, it will also be easier to access bigger loans, or easier to pay back the loan as you will lower interest rates and save on repayment costs.
- An excellent credit rating gives you more bargaining power – this is helpful when you are taking in new investors into your business, need a new loan, and so on.
- You can get better insurance deals when you have an excellent rating.
- You can get better business premises and business or home rent options with better ratings. Some upscale landlords screen would-be tenants by using credit ratings.
- Better credit terms as a result of an excellent rating create room for faster and easier growth and expansion.
- It is easier to market your business or services when you have a favourable credit rating to back you up. That is, you can use a favourable report as a marketing tool.
Disadvantages of a bad credit rating or bad credit score
- A bad credit rating can mean a lack of access to credit, and thus inability to grow or sustain a business.
- A bad credit score may result in paying higher rates for any credit services attained, resulting in a higher cost to the individual or business.
- A bad credit score is a negative reflection on the company or borrower. It means that anybody who views your report will consider you “unreliable or untrustworthy.”
- It affects business expansion as negative credit reports may adversely impact access to credit or investors.
- Some employers, especially financial services companies such as banks, investment management and insurance companies carry out background credit checks during the recruitment screening process. Hence, a bad credit score can cost you that dream job if your potential employer finds that your credit score and the way you handled your financial affairs in the past is poor!
- You may lose potential clients or major business deals if they realise that you have a poor credit rating and therefore a business risk.
- You are likely to pay higher insurance premiums if your credit score is weak – especially as insurers usually charge higher premiums when the risk of repayments is high.
- The limitations and the costs of bad credit ratings may spill over to your personal life since you may not be able to access credit facilities when in need.
How to maintain an excellent credit rating
The following are ways you as a business person can ensure an excellent credit rating (or how to keep a good credit score as an individual).
- Make payments in time or on time, always. Avoid late payment of bills or debts.
- Maintain debts that you can manage; this includes loans and credit card balances that you can quickly repay at the specified time. If you allow debts to pile up, you are likely to be overburdened by debts and end up with a poor credit score or rating.
- Do not get rid of positive credit history. Closing accounts or credit cards with positive credit history may cause you to lose that history as the agencies update their records, and as a result, this may impact your good to excellent ratings
- Do not borrow unless you have to. Some people take out a hire purchase just because the credit or loan is available. Put a limit to your borrowing, even if the option is available.
- Keep tabs on your credit reports. Find out where you can access your credit report, and compare past reports with the current. Are you maintaining a favourable report? Are there improvements? One credit rating UK site is Experian.co.uk. It offers not only credit rating free reports but financial advice as well.
- Keep accurate and up-to-date records to ensure that you know when your debts are due to be paid.
- Maintain good cash flow. Having an effective cash flow systems ( covered in one of my earlier blogs) helps to ensure that money to service credit and make payments on time is available when needed. When you manage your repayments on time, this creates an overall positive impact on the credit file, especially when loans and credit card payments are always on time.
How to track your credit score
Here are some ways to keep track of your credit score.
- Some credit scores come with tracking features. Talk to your financial services provider and find out if they have this type of credit card. Some of these cards are Barclaycard, Discover and Capital One.
- It is advisable for you to have access to one or more credit report bureaus – some of much cheaper than you might imagine. You can easily find a credit report bureau that is active in your country or even in another online. Some websites provide free credit scores using your financial information. However, it is always advisable to use those credit rating agencies that are well known and operates in your country.
In conclusion, a good to excellent credit rating is very important for you as an individual and for your business. Business is more comfortable to manage when access to credit and loans is easy. As noted above, a good to excellent rating also helps you get cheaper and affordable credit, saving on costs. Besides, it also makes a good impression on potential investors, clients or customers, creating room for more business deals and expansion. It is, therefore, time to pay great attention to your credit rating or credit score. It can make a whole lot of difference not only to your finances but to your business as well.
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