To a mortgage professional there’s nothing more frustrating than spending time preparing and submitting an application on behalf of a client, only to find it’s declined due to a credit problem. Let’s have a look at the truth about credit scoring.
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What can often add insult to injury is learning that the credit problem in question is something as small as a paid default to a phone carrier, often an event that took place years prior. This situation can be very difficult for a client to grasp; after all, such a listing may not at all represent their current financial position or ability to service a loan.
Being refused funding for minor credit listings
From a client’s perspective being refused finance due to, what in their opinion is a non-event, can be highly confronting and often leads to a feeling of distrust towards their financial representative. Many clients start to ask the question “Does this person really know what they are doing?”. This suspicion can be a very hard position for a mortgage professional to recover from and the loss of the client can be the unfortunate outcome.
How is it that seemingly small historic credit listings can have such disastrous effects? The answer is how such an event impacts on an individual’s credit score.
Let’s take a closer look Equifax’s credit scoring. The concept is simple, to provide credit providers with a highly visible scoring system that is designed to assist with their credit process. A person’s credit score is affected by many factors such as credit enquiries and negative listings like payment defaults. Even a person’s age, employment history and change of address can impact on a credit score. Naturally, the programming behind this system is a tightly guarded secret with very few people fully understanding the mechanics.
Here’s the truth about credit scoring:
Credit scores start at -200 and finish at 1200; the lower the score the higher the risk is considered to be. A score of 200 represents odds of 1:1 which equates to a person having a 50% chance of having an adverse event on their credit file within the next twelve months. For every additional 100 points the odds double meaning a person has less chance of experiencing an adverse credit event.
So what would a credit score of 300 mean? According to Equifax, a person with a credit score of 300 would have a 33% chance of having an adverse credit event within the next twelve months. Do you think a person with a credit score of 300 would have an easy time securing finance? I don’t think so either. Of course, each credit provider carries their own policies and what might be acceptable to one lender might not be to another, however, consider that even a score of 400 still reflects a 20% chance of trouble to a lender and in this market, I’m sure that would be sufficient to cause trouble.
What does it take to have a credit score of around 300?
When this client came to us he had a credit score of 390. After looking at his credit report the only negative listing was small paid telecommunication listing that was more than two years old. This seemingly insignificant event meant that a potential credit provider would assess an application on the basis the applicant has over a 20% chance of experiencing credit issues in the next twelve months. With this understanding, it’s no surprise this person was having trouble getting finance approved and was highly frustrated, as to him the listing was irrelevant and not at all a reflection of his current position.
With the removal of this listing, his credit score instantly moved from 390 to 577. According to Equifax this was the difference between over a 20% chance of a negative credit event in the next twelve months to well under 10% and to the client the difference of turning a decline into an approval.
This is not in any way questioning Equifax or how credit providers assess risk, it’s just to demonstrate how even one small credit event has the capacity to impact on a person’s ability to secure credit for years.
Even though many credit providers would no doubt agree that declining an application based on such a credit listing does not necessarily reflect an accurate determination of a person’s risk profile, the fact remains that the very reason credit providers subscribe to credit reporting agencies is to assist them with risk assessment and not following this process would be counterproductive.
So what can be done about this? Unfortunately, there is no simple answer; while it’s true that many negative listings can be removed from a credit file, the state of the world’s economy and in turn the Australian financial markets would suggest that restrictive lending policies will continue for some time meaning little relief for people with poor credit scores.