Credit scoring is the numerical expression which seeks to conduct an analysis of individuals or corporations credit history, with the aim of establishing credit worthiness. The information credit scoring is based on is predominantly retrieved from the information held by credit reporting bureaus such as Veda Advantage and Dunn & Bradstreet.
Lenders such as banks and credit card companies use credit scoring to determine if they are prepared to lend to consumers or organizations. Organizations such as mobile phone companies, insurance companies and government departments also use credit scoring as a technique in determining credit worthiness.
Credit scoring is the primary way an application for finance or credit is assessed in Australia. A Credit Scoreimpacts the creditors decision process in (2) main ways.
- To determine if credit should be approved.
- To set a credit limited which the applicant shall be approved on. This is typical for credit cards and trade accounts.
Lending Institutions and Creditors do not use the same credit scoring model; each organization adopts its preferred method. Some of the methods used are (MARS, CART, CHAID & RANDOM FORESTS). It is difficult to elaborate on these methods as they involve complicated mathematical formula, and as such are best left alone. However, the ingredients feeding the formula should be explored further.
WHAT FACTORS ARE CONSIDERED WHEN CREDIT SCORING?
Credit scoring takes into consideration (5) factors in producing a score which is acceptable to credit providers.
- Credit: Your current and past performance is taken into consideration.
- Capacity: Are you able to meet the repayments of a loan as and when they fall due?
- Character: Stability of work and residential address.
- Capital: What assets do you own?
- Outside factors: What factors outside your control affects your ability to pay back the loan?
The factors referred to above need to be looked at in greater detail, as optimizing a credit score will significantly improve one’s ability to obtain credit.
Current and past performance is an important factor looked at by credit providers. The history of previous loan conduct gives lenders good insight in determining credit worthiness and information held on a credit file is the best source for lenders to determine this.
The concept of credit extends not only to loans from banks or other institutions but also to trade accounts and utility bills. You must make sure creditors are paid on time and your account history reflect this.
You must keep enquiries for credit to a minimum. Each time a loan is applied for the application whether declined or approved is listed on your credit file. A high number of enquiries in a short period of time will cause a prospective credit provider concern, and may lead to your application being declined.
Creditors closely look at your capacity to service the credit applied for. There must be a clear ability to make repayments as and when they fall due.
Yours debts in total are looked at when considering capacity. You should resist applying for credit if your capacity to service is not apparent. Keep unnecessary expenditure to a minimum and establish a good savings record. All these factors advance your credit worthiness.
Credit providers keenly observe your pattern of behavior; they look for signs which suggest you are not stable. Lack of stability is a good indicator that you may not be capable of meeting your commitments.
The two main factors taken into consideration are:
- Length of time at the same work place. Normally a continuous period of (2) – (3) years in the same job is acceptable. If you have changed employment several times in the last couple of years this may present a problem.
- Length of time you reside at the same address. Once again lenders are looking for stability (2) – (3) years living at the same place continuously, is a good sign of this.
If you have experienced a period of instability as referred to above, you should refrain from applying for credit as you may be declined. Perhaps you should wait until such time as you have stabilized your situation thereby improving your prospects of success.
If you own assets credit providers consider this as a positive, in particular if you stand possessed of real estate this is most desired form of asset. Assets you possess may be wide and varied; assets which appreciate in value over time and are readily converted into cash are most likely to be positively considered by credit providers.
These factors are the most difficult to control and manipulate to your advantage. The forms these factors take are objective and in most cases are beyond one’s control. Such things as the prevailing economic climate and lending institutions tightening or relaxing of their lending policy.
Everybody should educate themselves on how to improve their credit score and become credit worthy.
Some worthwhile tips on achieving this:
- Keep all loan repayments on current loans up to date and meet all financial obligations including paying on time utility and phone bills.
- Limit the number of loan applications made.
- Keep liabilities to a minimum as prospective lenders take this into consideration when looking at serviceability.
- Try to present a stable pattern of employment and residential address. The rule of thumb is (3) or more years working and residing at the same place would be sufficient.
- Accumulate assets. Real estate is the preferred type. However, other assets such as share are also considered as positive.
- Try to minimize the impact of external factors. If you know the economy is struggling hold off on applying for credit until things turn around.
- Prior to applying for credit understand the specific requirements of each lending institution. As a broker do not to formally submit an application for finance until it has been assessed for its merits.
- Keep the amount of enquiry “footprints” on your clients credit file to a minimum. Caution your clients that making an enquiry for finance on the internet may lead to an application being lodged with an institution. Numerous applications may lead to future finance applications being rejected.
Joseph Trimarchi Solicitor