Credit assessment and reporting

Contributed by Ian Macdonald and current to 1 September 2005

CREDIT ASSESSMENT

Credit providers use a variety of methods to assess any credit application. Precise details of how these methods are applied by particular credit providers are difficult to obtain, as most credit providers regard this information as confidential. However, the following is a description of three common methods that may be used by credit providers to assess loan applications.

Risk – reward assessment

The business of lending is directly related to the management of risk, as the lender aims to minimise risk and to maximise return. Credit providers aim to avoid high-risk or troublesome loans that could result in unproductive administrative time trying to generate repayments or institute recovery proceedings, or even a loss to the credit provider.

Usually a lender will consider the following lending principles when assessing an application:

• personal factors;
• purpose of the loan;
• amount and term;
• repayments; and
• security.

The last two factors are related to the customer’s capacity to repay the loan. The ability of a customer to repay a loan is obviously crucial to both the customer and the credit provider. Good lending practice would require that the loan is properly assessed and the amount and term are appropriate for the borrower’s particular circumstances. Security should be taken only as a last step in the assessment process in order to insure against unforeseen and unfavourable changes of circumstances involving the borrower.

However, consumer groups have long argued against a practice called asset lending where the availability of security, not the consumer’s ability to repay the loan, is the paramount consideration in granting the loan.

Credit reference checks

There is no general legal obligation on credit providers to undertake a credit reference check. Yet, while such checks are becoming increasingly cheap and simple via on-line connections, the time may soon come when failure to undertake such a credit reference check will be viewed as running a risk which, if realised, should be borne by the credit provider. Credit reference checks are particularly valuable for avoiding consumer over-commitment because they reveal not only existing debts but also other credit enquiries made concurrently.

Credit scoring

Credit scoring is a system where the answers to routine credit assessment questions, such as length of residence and employment history are scored numerically. Both the questions and the scores for answers are based on statistical data collected from loan approvals and rejections for similar lending products. Credit scoring works on the principle that outcomes are accurately predictable on an aggregate level in a large population.

There are two types of credit scoring used in Australia:

• Application scoring is used when the application is first assessed. The application is calculated from information available at the time of application. This typically consists of information from the credit application form, a credit report and possibly the applicant’s performance on other accounts if the applicant is an existing customer of the institution. The application score is used to inform decisions taken at the time of application – such as whether to accept or decline the application.

• Behaviour scoring is used once the loan is on the bank’s books. It monitors the performance of the customer’s accounts over time and compares their performance to other similar accounts. The behaviour score is used to inform decisions taken through the life of the account. Typical decisions would concern the collections’ strategy to follow and the length of the credit card renewal period.

CREDIT REPORTING (See also DEBTS and PRIVACY RIGHTS)

A credit reporting agency holds information about an individual’s credit history in a credit information file and provides that information in the form of a credit report to credit providers. It does not itself assess an individual’s creditworthiness or provide a credit rating.

Information about current credit providers and applications for credit and default information is held by an agency in credit information files. An agency’s use and disclosure of credit information files is controlled and limited by the Privacy Act 1988 (Cth) and a legally enforceable Code of Conduct issued by the Privacy Commissioner under the Privacy Act.

Access to information held by an agency is restricted to credit providers and individual consumers. Real estate agents, insurers, government licensing bodies, debt collection agencies, etc are not entitled to access an agency’s information. An agency holds some information purely for identification purposes (name, sex, current address, previous two addresses and driver’s licence number).

Currently there is no provision for positive information (such as that a loan has been paid out early, or that payments have always been made on time) to be noted on the file or for information about an individual’s assets or income to be included.

The Privacy Act sets out five types of default information that can be recorded:

• payment defaults – the payment must be at least sixty days’ overdue and the credit provider must have advised the borrower in writing that the payment was overdue and requested payment;
• dishonoured cheques – the amount of the cheque must exceed $100 and must twice be presented and dishonoured;
• court judgments – the judgment must be of a court not a tribunal but need not relate to credit; for example a motor accident claim or other litigation can be recorded;
• bankruptcy orders – only orders can be recorded, not debtors’ or creditors’ petitions or personal insolvency arrangements.
• serious credit infringements – this is defined as fraudulent attempts to obtain credit, fraudulent attempts to avoid credit obligations, or actions that a reasonable person would consider indicate an intention on the debtor’s part no longer to comply with the debtor’s obligations in regard to credit.

Information held by an agency is not held on the file forever and must be deleted after certain periods of time:

• credit inquiries – five years;
• current credit providers – 14 days after notification by the credit provider that they no longer provide credit. The credit provider must themselves advise the Agency that they no longer provide credit within 45 days of ceasing to provide the credit;
• payment defaults – five years from when the agency was informed of the overdue payment;
• dishonoured cheques – five years from the date of the second dishonouring;
• court judgments – five years from the date of the judgement;
• bankruptcy orders – seven years from the date of the bankruptcy order;
• serious credit infringements – seven years from the date the information was included in the file.

INACCURATE INFORMATION

Both credit reporting agencies and credit providers supplying information to them are obliged to take reasonable steps, including making corrections, deletions and additions, to ensure information included in credit information files and credit reports is accurate, up to date, complete and not misleading.

Where a consumer requests an amendment to a file entry the agency must, within 30 days of receiving the request, either amend the entry as requested or advise the consumer of :

• the reason for the amendment not being made;
• the consumer’s right to have a statement attached to the disputed entry detailing the requested amendment;
• the consumer’s right to make a complaint to the Privacy Commissioner;
• the fact that credit reporting agencies and credit providers are prohibited from giving a credit report which contains false or misleading information and, if the information is given knowingly or recklessly, that they will be guilty of a criminal offence.

CREDIT REFUSALS

If an application for credit is refused by a credit provider and the refusal is wholly or partly based on information contained in a credit report, the credit provider must advise the person in writing that the refusal is for that reason and also of the individual’s right to access the credit report from the agency concerned.

If a credit provider refuses an application for credit on any other basis they are not obliged to inform the individual of the reason for the refusal.

DO I NEED A GOOD CREDIT RATING?

A common misconception amongst consumers is that if they do not have a borrowing history and a good credit rating they will not receive finance. Many consumers, especially young people, will enter into small, high interest loans to establish a borrowing history and a good credit rating in circumstances where they did not really require the credit. They may have problems paying back the loan because of the high interest rate and their marginal capacity to make the repayments.

As noted above, credit reference agencies do not provide positive information to potential credit providers about the past payment record of consumers under other loan contracts. They provide only negative information about defaults, serious credit infringements and the like.

Potential credit providers will take into account a borrower’s past credit experience when assessing their application for credit, but this is only one relevant factor that they will use. Past credit experience is only vital in credit assessment if there is a poor credit record. Credit providers are concerned with a borrower’s stability, ability to make repayments, and the quality of security offered rather than whether the potential borrower has had a loan previously.

This is particularly true for housing finance. Many consumers believe, erroneously, that a borrowing history and a good credit rating will particularly assist them in obtaining housing finance. Credit providers encourage applications for housing finance and will usually grant them if they are satisfied with the value of the property, the deposit paid and the ability of the borrower to make the repayments.

Borrowers should only borrow when they require finance and not to establish a borrowing history that has very little value to them for future borrowings. It is a very expensive path to go down for something that has only marginal value.