Lenders know the score

Applications for credit meet a speedy response these days, thanks to a statistical technique which can tell instantly whether the candidate for a loan is a good risk or not. By John Andrew
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Have you ever thought how it is that lenders assess their willingness, or otherwise, to grant a loan or other form of credit so speedily? Fill in an application form, or apply by telephone to a direct loan service, and you will normally know within minutes or later that day whether your request to borrow has been approved.

The almost instant decisions are possible because of the use of a statistical technique known as credit-scoring. It is by no means a new concept. The first experiments started in the United States in the 1940s, but it did not become widely used commercially there until the late 1960s.

The credit industry in the UK started to use the technique in the 1970s, and now almost all decisions to open personal bank accounts, issue a bank or credit card, or lend money to individuals, use credit-scoring as part of the process.

It largely removes the subjective human judgement from assessing whether an applicant is a "good risk". In the past, although those responsible for making the decisions had basic ground rules to follow, their decision- making process was a fairly arbitrary affair. For example, in the US, credit managers of the old school would not lend to the three Bs - beauticians, bar-tenders and barbers.

Credit-scoring largely removes all personal bias from the decision-making process. As it can be used by quite junior members of staff, it also speeds up the application process. The system works by identifying and allocating points to various characteristics such as age, occupation and residential status, which have been shown statistically to help predict whether an applicant is a good risk.

The score chart is based on the lender's past experience. Analysis of the application forms for a large sample of an equal number of randomly selected accounts in which the history has been good or bad, provides a statistically representative cross-section of past histories. So that the data is fully representative, rejected applications are also analysed, with inferences about whether, if accepted, they would have turned out good or bad. The information about the applicants is used to isolate the data which characterises the good as opposed to the bad customers.

Between eight and 12 characteristics are generally identified. Mathematical techniques are used to evaluate each characteristic in relation to its significance in the sample of good as opposed to bad payers. The analysis may reveal that a divorced person is a better risk than a single individual, but less sound than a married man or woman.

A single applicant may therefore score five, whereas marks of 10 or 16 may be awarded respectively to divorced or married applicants. Similarly, home-owners will receive higher scores than those living in rented accommodation, as will people who have a permanent employment contract and have worked for one employer over many years. Many other characteristics are graded in the same way.

The scores awarded to each characteristic are then totalled and the odds of risk are calculated. The higher the points the less likely you are to default. For example, a score of 50 may indicate that one out of 20 borrowers will default. The minimum score is set at the level which gives the provider of the service an acceptable level of risk.

Credit-scoring is only part of the decision-making process. With applications for credit, income and existing commitments are also taken into account. Clearly lenders will wish to satisfy themselves that any line of credit is within the applicant's means. It is also likely that a credit reference agency will be consulted. Their records will reveal whether the applicant is on the electoral roll; has county court judgments; if anyone else has carried out a search; and if there has been default with any other credit arrangement.

No one likes to be turned down when applying for a financial service, but it does happen. Some credit-providers have more rigorous criteria than others, so rejection from one quarter does not necessarily mean that the applicant will not be successful elsewhere.

However, it is well worthwhile asking the reason for the rejection. If it is an adverse report from a credit reference agency, on payment of a pounds l fee individuals can examine the information the agency holds about them. In cases where it is inaccurate, the agency is obliged to correct errorsn


Stability is a crucial factor. The longer an applicant has been employed by the same company or lived at the same address the better. Home-ownership and a land-line home telephone also indicate stability.

Occupation normally plays an important role, with professionals generally scoring more than skilled people, and unskilled employees the lowest.

Disposable income, as opposed to total earnings, is important. As a rule of thumb, to spend less than 30 per cent of annual regular earnings before tax on credit repayments falls within the safety limit. Ideally, non-mortgage credit commitments should be less than 5 per cent of gross regular income.

Traditionally creditworthiness increases with age, though it can dip for those in their thirties and forties.

County court judgments normally negate a good credit score. They remain on file until the end of the sixth year after the judgment was made. Credit reference agencies, if asked, will place a notice on the file if a judgment does not relate to credit - for example, if there is a dispute about the goods supplied as opposed to a borrower not meeting his/her obligations under a credit agreement.

Reformed bad payers who are graduates of the debt programme run by the Foundation for Credit Counselling, an organisation which gives free advice to the over-indebted, can effectively have a veil placed over their past. The Foundation will ask the agencies to place a notice on the file advising searchers that the individual is a graduate of the Programme. The Foundation may be contacted on 0345 697301n






ROB and June could not believe their luck when they were offered a building- society-repossessed house in west London for pounds 20,000 below the market price. However, despite saving a sizeable sum, Rob maintains that he will never again purchase a home where there has been a mortgage defaulted.

The problems began just before they moved in. Although the couple had owned their own property for years and had never run up bad debts, both the electricity and gas companies refused to supply their services other than by prepaid meter. Rob's protests that he had been a good customer for years went unheeded. As time was of the essence, he reluctantly agreed.

Then BT would not connect their phone unless they paid a hefty deposit. Rob paid reluctantly, but asked why, as a good long-standing BT customer, he was being treated in this way. He was told that there was an adverse credit reference agency report. Rob paid his pounds l and obtained a copy of the report. Despite their surname being completely different from the previous occupants - who had not only defaulted on their mortgage, but also a host of other loan agreements - their county court judgments appeared on Rob and June's file.

The credit reference agency placed a notice on file which made it clear that the judgments related to the previous occupant of Rob and June's home. The couple thought all was now well, until they were refused interest- free credit on a carpet offer. This time a different credit reference agency was used, but again their file showed the judgments against the previous occupants of their home. The matter was again resolved.

Rob and June were refused credit, or the supply of service, six times before all files at credit reference agencies were corrected. "We laugh now, but at the time it was not funny," said Bob. "We manage our money carefully and have never been in financial trouble. To be treated as uncreditworthy was just so embarrassing," he added. BT refunded their deposit, but refused to pay interest on the money.

They still have prepaid gas and electricity meters, as to change to an account system would be too much hassle. They are reminded of their period of living hell every time they forget to charge their pre-paid meter ... and their home is plunged into darknessn

John Andrew

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