By James Jones from Experian

Credit checking is a mystery to some, so how does it work?

Basically, lenders obtain your consent to share and access information about your credit agreements through credit reference agencies like Experian. We combine these records with others, such as court judgments and insolvencies, to create what is called your credit report. We can produce a credit report for most adults in the UK.

You will usually give the lender permission to check your report when you apply for credit. If your report shows that you’re a reliable customer then it can help you get the credit you ask for. Most lenders use a technique called credit scoring (or ‘credit rating’) to help them work out the chances of you repaying credit, based on your credit report and any other information they have about you.

Despite frequent reports of an impending debt meltdown, the credit report data Experian hosts show that the vast majority of people continue to meet their credit repayments. The average Experian Credit Score – which is a guide you can get with your own credit report – is 783 out of 999* and this has increased steadily over the past few years. However, it’s clear that many people are worried about repaying their debts and, from the increasing workload of free debt advice providers like Payplan, that more people are seeking help.

If you’re in this boat, you might be considering a Debt Management Plan (DMP) to help get your debts under control. The state of your credit rating is likely to be way down your list of priorities, but you might still wonder what effect a DMP will have on your creditworthiness.

DMPs aren’t themselves registered on credit reports, but lenders can add a marker to your credit agreements to show you’re repaying your debts using a DMP. They can only do this for debts that haven’t already defaulted (see below), to demonstrate that you are proactively repaying your debts at an acceptable level.

The DMP marker should show your old and new monthly payments. Unfortunately, the monthly updates your lenders make will usually show the accounts falling into arrears (i.e. you getting behind with your original repayments). But as long as you keep up the new payments through your DMP, the arrears registered on your credit report will never exceed six months and, importantly, each account will stay out of default. Defaulted accounts show that the lender/borrower relationship has broken down, which is very bad news for credit scoring.

Once you complete your DMP, each account can either be returned to good order or closed, in which case it will stay on your credit report for a further six years. Credit assessment tends to focus on your most recent credit history and should take account of the age of any late payments, plus the fact that they occurred while you were taking positive steps to deal with your debts.

You can add an explanatory statement (a ‘notice of correction’) to your credit report and you could use this to explain why you got into difficulties in the first place. You could also use this to flag up a current DMP if your debts have already defaulted, or will default because you are only able to make very small repayments. There is guidance on how to word your notice on the Experian website.

The key issue is that, if you stick with your DMP, you’ll be back in control of your debts. And no matter how severe a credit scoring hangover you are left with, time is a great healer and your credit record will soon recover.

* – January 2012