What steps do lenders take when you ask them if you can borrow some money, whether it's for a loan, a credit card or a mortgage?
Banks have recently reported a sizeable increase in the amount of money that they have to write off because so many people have defaulted on their loans and credit cards.
Of course, debtors have to take responsibility if they've borrowed more than they can really afford but lenders must also take part of the blame for making credit all too easily available.
Not surprisingly, lenders are being more careful when they select potential debtors these days, but they still base their decision on three factors.
1. Your application form
Lenders obviously need basic information from you such as your name, age and address, how much you earn, how much you want to borrow and why.
There'll be certain questions that might seem irrelevant to you but the information you give will be used to build up a profile of you and your circumstances. This will enable them to 'score' you by allocating plus or minus points for information that they regard as good or bad.
2. Your credit files
Next they'll carry out a search of your credit files. These play an important part in showing how well (or not!) you manage your finances because they contain details of any County Court Judgements and bankruptcies. Alongside that will be information passed on to them from various banks and building societies about your payment history for cards, loans and mortgages that you already have, how much you've borrowed and how much credit you have available to you.
There are three credit reference agencies holding this sort of information -- Experian, Equifax and Callcredit -- and, as you have a right to see the information they hold on you, it's a good idea to send off for them occasionally to make sure the information they hold is correct and to ask for factual details to be rectified if a mistake has been made.
Every time a search is carried out it is logged on your files and that information is available to every other lender who needs to access it. In some cases, this can go against you -- for example, if you have approached several banks, it might appear that you have looking for lots of credit and have been turned down even though you may have a perfectly good reason for not proceeding.
If you go ahead with your application and you meet your monthly obligations on time, then your payment history for that particular borrowing will show up on your file as a series of zeros for each card or loan that you have. If you are late with your payments your track record is automatically altered even if you miss just one payment.
However, it's the Default notices and County Court Judgements which are of most concern to lenders and as these stay on your files for six years, even if you eventually manage to pay them off, it can still affect your chances of getting further credit. You'll either be turned down flat or you'll be charged a higher-than-usual interest rate.
If you have a bad record because of late payments, defaults or County Court Judgements, then there's not much you can do to improve matters except to make sure that your payments are on time in the future.
3. Your credit score
Finally, having checked your application form and your credit reference files, your prospective lender will then use that information to give you marks to determine whether you are a good or bad risk.
Each lender has different criteria when calculating your credit score. It depends on their target market and whether they want to lend money to people like you. It works on a points system: the more points you get, the more likely it is that you'll get credit.
Factors such as being married and being a homeowner will probably score highly because it'll imply stability. Your postcode may also be relevant because it indicates whether you live in an affluent area or not, but having lots of children could count against you because kids are expensive!
The most important thing is to make sure you are on the electoral roll. If you don't show up as being on the electoral roll, most lenders will automatically refuse you credit. So if you've recently moved, phone up your local council and ask to be registered as soon as possible.
Find out how you can get a free copy of your credit report in our Credit Report centre.