Common questions people ask when going through the mortgage process are “what is my credit score, how does it work and why is it important?”.
This post goes beyond the basics and also explains how Australia’s new credit reporting regime (“comprehensive credit reporting”) introduced in March last year effects you.
The new regime along with a borrower’s ability to demonstrate positive credit behavior ultimately means borrowers can get better deals on their home loans, so read on…
Overview
In Australia both borrowers and lenders have access to credit scores (also known as credit ratings), and credit reports (also known as credit files).
Credit reports are provided by credit reporting agencies whose business it is to collect credit information from companies like banks, telecommunications and utility companies. These same companies then use the reports to assess new credit applications, by determining the credit worthiness of borrowers.
Each person has their own unique/individual report which is created when they first use or apply for credit. It is constantly updated and contains information such as:
- credit enquiries, e.g. applications for personal loans, credit cards or mortgages
- credit defaults and infringements, e.g. payments overdue greater than 60 days
- personal bankruptcy information
- judgements including writs and/or summons from Australian courts
- public record information such as directorships
Your credit ‘score’ on the other hand, is a single number calculated from information on your credit report. A borrower with a higher score is deemed to be more credit worthy, and therefore presents a lower risk to the credit provider. Your score is dynamic in that it changes when information is added or deleted from your report, so it can either improve or deteriorate over time.
Both credit reports and credit scores are used by lenders to determine whether the applicant can borrow, how much they can borrow, and at what rates. They’re not the only tools used to make the decisions, but they’re important ones, so borrowers are advised to maintain strong files.
Black marks on your credit report will negatively affect your ability to get a loan
A troublesome credit report, for example where there are declined applications and defaults, will not be looked favourably upon by a lender and could lead to an application for credit being rejected. The same is true for more serious situations like court summons or bankruptcy.
However a number of lenders (particularly the smaller specialist lenders) may be more understanding with less severe issues. Say for example you had an overdue utility account on your credit report. You might still be approved for a loan if have a plausible explanation and have either made plans for the debt to be paid, or you are raising the matter with a dispute resolution service.
Check your credit report before you next apply for a loan
Given the importance of one’s credit report for obtaining a loan, borrowers are encouraged to obtain a copy of their report to check for any black marks and/or inaccuracies:
- Are your name and date of birth correct?
- Is your address up to date?
- Are there any debts listed which you aren’t aware of, or disagree with?
- Are any listings for payments not yet 60 days overdue?
- Does any information on your report lead you to believe that someone might have attempted to steal your identity for the purposes of obtaining credit?
How to get your credit report (paid and free)
The two main credit reporting agencies in Australia are Veda Advantage (previously named Baycorp Advantage) and Dun & Bradstreet. Both agencies record and file credit information on millions of Australian individuals and companies.
Individuals and businesses are both able to obtain free and/or paid copies of credit reports.
Paid reports – You can obtain your credit report from Veda for $79.95. This paid option also entitles you access to an email alert service whereby you receive notifications when report changes. Dun & Bradstreet offers your credit report for $30, or $60 if you opt for the email alert service.
Free reports – You can obtain a free copy of your credit report from either agency in any of the following circumstances:
- Once every 12 months; and/or
- When you have a credit application declined due to content in your report; and/or
- When you lodge a correction request and are advised that information on your report has been corrected
The paid report and free report are identical, however it takes 10 days for either agency to send you the free version (by post) whereas the paid version is delivered immediately via email.
To request either the free or paid copy from Veda, go to www.veda.com.au (or their affiliated website www.mycreditfile.com.au ) and follow the links.
If you prefer Dun & Bradstreet, go to www.dnb.com.au (or their affiliated website www.checkyourcredit.com.au ) and follow the links.
9 tips for maintaining a high credit score
Maintaining a strong credit score will maximise your chances of being approved for your loan, and obtaining competitive offers. Here are nine simple strategies which will help tremendously:
- set up direct debits to ensure bills are paid on time
- schedule loan repayments for after payday so that there are sufficient funds in your account
- keep track of credit commitments and only apply for new credit when you really need it
- credit includes things like store finance so don’t neglect payments on your fridge or car if you have bought these sorts of items on such terms
- close any accounts you no longer need
- get your bills via email and flag them to make sure they’re paid on time
- manage your expenses such that you can always afford to pay your debts
- if you’re having trouble meeting payments, ask for an extension or negotiate new terms
- get a copy of your credit report and check for any black marks (so you know where you stand) and any inaccuracies (so they can be corrected)
Australia’s move from positive to negative reporting
Historically Australia has operated in what’s known as a “negative” reporting environment where only negative information like credit defaults and infringements were recorded.
However in March 2014 “positive” reporting started being phased in. Now information can be recorded such as dates that various accounts were opened/closed, credit limits and most importantly – 24 months repayment histories.
What’s interesting though is that since positive reporting was introduced it has been opt-in for lenders, not compulsory. And as at the time of writing none of the big banks have volunteered the positive credit information that the new regime intended, probably due to the competitive advantage they maintain by keeping it to themselves.
Positive reporting is also known as Comprehensive Credit Reporting (CCR). Not only is CCR the framework used by most developed countries around the world, most other countries have more data currently available to borrowers and lenders even than what is proposed (but not currently being provided) under CCR in Australia.
It was reported in The Australian last month that NAB may be releasing positive credit data soon, but the other majors are continuing to resist. The industry expects significant levels of credit data will only be exchanged in late 2016 or early 2017.
It’s interesting that a country the size of Australia has banks that rank in the top bracket globally of banks by market cap and profitability. So it would be incorrect to suggest that negative reporting has hurt the majors.
The sense is that they don’t need external (positive) credit data because they already have so many customers themselves. They have their own loan book which has all the data they need, so there is less incentive for them to share this kind of data as it will be of enormous value to newer competitors.
The new regime benefits borrowers and lenders
For lenders it’s about automating processes and better pricing risk:
- With the richer data (including insights from applicants with multiple lending relationships) Australian lenders can develop better insights into the credit worthiness of borrowers, which can increase profitability through the reduction of bad debts and the identification of more suitable borrowers.
- Lenders can also benefit from increased automation due to expanded information about each borrower which can be analysed by computers, rather than people.
From a borrower’s perspective, CCR provides an opportunity to demonstrate credit worthiness which makes it easier to obtain credit and get a better deal.
- Positive credit behaviour can help borrowers recover faster from adversity. Borrowers can demonstrate good credit behaviour because the new system records if they have made payments on time, this may counter the impact of negative events such as defaults.
- Positive credit behaviour can establish a positive credit rating quickly. Previously young people or recent arrivals from overseas could obtain credit but (provided they didn’t default on any payments) many would essentially have blank credit reports. They may be credit worthy borrowers but credit providers may still consider them as being risky, and either not lend to them or insist on higher rates.
- Positive credit behaviour can result in being offered better deals: Borrowers who can demonstrate positive credit behaviour (rather than just ‘no negative behaviour’) will have more negotiating power when dealing with lenders. This enables borrowers to be rewarded with better offers.
New innovative lenders are entering the market, but with inadequate information
Marketplace or peer-to-peer (P2P) lenders are a new type of finance company connecting borrowers with investors (their lender/funders) via an efficient online marketplace. The efficient link between borrowers and lenders reduces bank overheads resulting in benefits for both parties – higher returns for investors and lower interest rates for borrowers.
At present most P2P loans are unsecured personal loans, rather than mortgages, but the concept is likely to extend to Australian mortgage lending over time.
These new lenders rely on CCR in that they run algorithms over credit histories to more accurately and efficiently price risk. This is called risk based pricing and it is how credit worthy borrowers can obtain lower interest rates through P2P lenders than might otherwise be offered by banks. In a negative reporting environment risks cannot be assessed accurately so strong borrowers end up paying higher prices which in effect subsidise the entire pool of borrowers.
Due to the limited/voluntary participation of CCR in Australia, P2P lenders are being forced to operate with workaround solutions. Rather than relying on positive credit data from agencies like Veda or Dun & Bradstreet (which isn’t available yet), in order to offer borrowers discounted pricing they are requiring applicants to demonstrate their credit strength by manually submitting payment summaries and statements which need to be verified.
This practice is less accurate and more costly than running automated algorithms over readily available data provided by agencies, and ultimately borrowers have to pay for this, but in light of the limited data it’s still adding value in that better lending decisions are being made and borrowers are still getting cheaper rates.
Conclusion
In the spirit of “fighting for Australian homebuyers and property investors”, it is Soldier Tom’s view that there should be legislation to mandate participation into CCR if the voluntary arrangements for lenders are shown to be inadequate. It would enable a fairer system and allow millions of Australians to get a better deal… initially on their personal loans, and eventually on their mortgages too.
