Is credit scoring fit for purpose?
Credit scoring is a system which can have a big impact on many of our lives, yet in the UK it is one that we don't seem to be fully across as a nation. A recent study by Experian - one of the three main credit reference agencies in the country – found that nearly half of us (47 per cent) haven't even checked our credit report before. And of those who have, just a quarter actually know what their credit score is.
A natural consequence of this is a fundamental misunderstanding of how credit scoring actually works, and what actions help or hinder your credit rating. And few people probably realise just how much information about themselves is in the hands of these three companies.
How are credit scores determined?
Experian, along with Equifax and TransUnion (formerly Callcredit), have access to most of your key personal details: whether you're registered to vote, your spending patterns, outstanding debts, shared accounts, credit application history, county court judgements (CCJs) and much, much more. They collate all this information in order to impartially establish your creditworthiness, and simplify this construct into a basic numeric score.
Although the specific scoring system varies across the three agencies, they glean information in much the same way - combining publicly-available data with information acquired from lenders and fraud prevention agencies. They also incorporate derived data, which is inferred from other information such as shared financial commitments with a spouse or partner.
Ultimately, lenders and other financial institutions foot the bill for these credit reference agencies to put all this information together in a standardised way, which gives them a foundation upon which to approve applications for credit in a fair way.
But is it actually fair?
In principle, the system provides a level playing field for consumers, and a simple platform for lenders to make educated decisions on credit applications. But, in reality, there has been no shortage of horror stories.
Journalist John Naish recently relayed his story in This is Money of how he fell victim to identity theft. The lender issued a loan to a fraudster using his name, demonstrating an astonishing lack of diligence in the process. It then set a debt collection agency on Naish, despite his valid explanations as to what had happened.
He escalated the matter to the Financial Ombudsman Service (FOS), who found in his favour. Yet despite this, the lender refused to scrub the 'default' from his credit file. The FCA proved to be of little help either, refusing to allow him to file a complaint, as they only accept these from organisations, not people. So, despite owning his own home, car, and never having defaulted on a loan in his life, Naish found himself in a position where, as he puts it, he "would struggle to get approval to buy a sofa."
Consumer website Which? cited another story of a 32-year old lady who took out a car loan from a company that later went bust. As a result, her direct debits began to be rejected, and, despite her best efforts, she was unable to determine how or to whom she should pay off the remaining debt. She later ended up with a CCJ, filed by a company - unbeknown to her, and who she had never heard from - who her debt had been sold to. Her credit score fell off a cliff as a result, with no recourse to resolve the matter, as CCJs can be filed unilaterally by the lender, without court proceedings actually taking place. In the end, she found herself unable to even rent an apartment.
While one would hope that such events are an anomaly, there are many other tales of injustice. Often errors, or unfair treatment are the result of decisions taken by the lender, but, invariably, they direct customers to credit reference agencies when there is a dispute. In 2017, the FOS fielded 910 complaints about credit reference agencies, which represented an 87 per cent increase on the year before. So, it does beg the question as to whether the current system is functioning optimally.
Is our personal data safe?
Given that they harvest such a monumental level of customer data, credit reference agencies have a big target on their backs for hackers, and indeed there has been a high-profile breach in recent times. In late 2017, Equifax's parent company in America fell foul of a cyber-attack, resulting in the theft of nearly half the US population's personal information. Although there was no direct breach of any systems over here, a file with data such as email addresses, phone numbers and card numbers pertaining to more than 15 million Brits was compromised.
Naturally, such an event undermines trust, but it must be said that no such breach has been reported by Experian or TransUnion, and the advent of GDPR should go some way to redressing the balance of power between the consumer and the credit reference agency (and/or lender).
For starters, firms are no longer able to charge a fee for customers to access their credit file. According to Which?, there are also clearer paths for recourse under the ‘right to rectification’ rule, whereby customers can now challenge inaccurate data, with the lender or firm obligated to respond without delay.
GDPR also means more stringent controls on how your data can be used, particularly with respect to marketing. It is now much easier to opt-out of any marketing communications, thus giving the consumer a greater degree of control.
How do I improve my credit score?
One thing you can't 'opt-out' of is credit scoring as a whole, so it's vital that you do what you can to improve it. First and foremost, get hold of your credit file from all three agencies. Remember, different financial institutions use different agencies, and, as they report your score differently, there may well be discrepancies. So have a look at your credit file(s), make sure there are no errors, and inspect the details so you gain a better understanding of what you're doing well, and what may be dragging you down.
We've published a comprehensive guide as to how to boost your credit score, but here is a basic outline of what to do, and what not to do...
- Register on the electoral roll
- Keep your credit card balance below 30 per cent of your limit
- Pay your car insurance off monthly
- Have consistent address history
- Attain the highest credit limits possible
- Make loan repayments on time
- Missing a payment
- High levels of credit card debt
- Low credit limits
- Numerous credit applications in a short space of time
- Loan defaults and CCJs
- No credit history
What does the future hold for credit scoring?
Despite the reservations many people may have, along with a lack of understanding among the wider population, the credit rating system is still undoubtedly a force for good.
The logic behind it is simple, and it delivers an unbiased, transparent apparatus that enables lenders to expedite things like identity and affordability checks when assessing credit applications - therefore ensuring a better customer experience. These agencies also play a pivotal role in terms of AML, and the battle against fraud. Additionally, the current system is a robust shield against the irresponsible lending which perpetuated the credit bubble in the build-up to the recent financial crisis.
GDPR will also play a crucial role in protecting our data, as well as ensuring we retain some control over a system which has an immense degree of power over what we can and can't do.
Yet in a world of rapid change, so must the current system keep pace – as should our institutions and services which serve to benefit the customer. Perhaps the day will come where the current one-size-fits-all approach is no longer appropriate, and something more nuanced is required. What that may look like in 10 or 20 years, who knows? All that is certain is that evolving with the times is a necessity if the current system is to endure, and for it to ultimately enhance the market for credit such that it develops into a well-oiled machine.
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