Credit scoring gets a shake-up

Summary: Australia's credit score reporting system recently changed from "negative" to "positive", a shift in line with international standards. 

Key take-out: Changes may make it easier for consumers and investors to turn their credit score around, however it isn't cut and dry.

Next time you check your credit score when applying for a loan or line of credit you may get a pleasant surprise.

But that’s not a blanket statement. First-home buyers may benefit from Australia’s new comprehensive credit reporting system, a shift in line with international standards. From September it became easier to turn around your credit position.

However, it will depend on several variables. Plus, the ongoing crackdown by lenders on mortgage finance could offset some benefits.

For the unacquainted, Australian credit reporting agencies Equifax, Experian and Illion are required to provide a free independent credit report to consumers at least once a year. Each agency places a different weight on different financial events.

Changes to credit scoring

The system has changed, but some things remain the same. A default will still stay on your credit report for five years and a late payment of more than 60 days can stay on your credit report for two years. Credit card usage, including the number of cards and their providers, will have an impact on your future home loan applications. Items like rent still won’t because it is classified as a ‘pre-payment’.

Steve Brown, the director of bureau engagement at Illion, says the new system gives a more complete picture of investor creditworthiness.

“The comprehensive system still retains the negative data but the positive data too, and this gives a complete picture of someone’s creditworthiness, commitments, and whether they are meeting those commitments on a daily basis,” says Brown.

“Historically in Australia, if you had difficulty managing your credit and a negative event on your file, you were essentially locked out of mainstream credit for five years – and there wasn’t much you could do. The comprehensive system works so if you have lines of credit that you maintain during that period it will potentially counterbalance or at least provide a more balanced picture of your position.”

Comprehensive credit reporting was introduced in Australia few years ago, though its adoption in Australia was limited. Now it’s mandatory, with the banks forced to share customer data with credit agencies.

What to watch for

A credit reporting agency doesn’t hold your credit score and instead calculates your score in real-time on request. Credit reporting legislation is prescriptive and mandates a report must include name, date of birth, licence number and employer. That information is put to adverse data including judgements of bankruptcies, defaults, and credit applications.

Credit limits also filter into the score, but only became part of the puzzle a few years ago. As an example, middle-income earners meeting their commitments on several premium credit cards with high limits may be looked upon less favourably than those without a credit history altogether.

“As well, who you get credit from is just as important as how much credit you are applying for,” adds Brown.

“Some of the short-term high-interest products – without naming names – could damage your credit score because the risk is perceived as higher. If a provider has an interest rate typical or close to a major bank, it wouldn’t be flagged as risky.”

For all the talk that a ‘positive’ system means more positive outcomes for investors, in terms of loan agreements, Brown takes a more nuanced view.

Previously the system placed the onus on the investor to be truthful about existing commitments before seeking additional credit. Now the system makes that data available to a broader spectrum of providers, from the "big four" banks right down to smaller banks.

“I can’t tell you the percentage it would be, but a small percentage of the population, by accident or deliberate omission, would have not disclosed all their commitments,” says Brown.

“The banking Royal Commission highlighted several examples, like individuals with multiple credit cards to support gambling addictions, who certainly weren’t disclosing existing cards. If you weren’t disclosing all your accounts, credit providers now have another mechanism to determine which accounts are open.

“It means a challenger brand providing loans in Australia suddenly has more information to lend more confidently and profitably. This increased level of access should drive down the cost of credit in Australia.”

It makes sense that Australian millennials have a lower understanding of credit than older generations. After all, millennials have less experience obtaining credit. More than half surveyed by consumer education site CreditSmart were unsure what a lender looked for in a credit report. 

An analysis by another credit score provider, CreditSavvy, recently found that millennials aged 25-34 have the lowest average credit score (624 points) compared to Generation X (659) and Baby Boomers (737). That’s drawing on Experian data and on a scale of 1000 points.

But a quarter of millennials (24 per cent) have checked their credit reports in the last 12 months, more than Gen X (20 per cent) and Boomers (10 per cent).

Start with the basics

Geri Cremin, credit reporting expert at CreditSmart, suggests starting with the basics.

“You’ll start creating credit history when you apply for a credit card, a post-paid phone or utility account, as long as it’s in your name,” says Cremin.

“Making repayments on time is the best way to build your credit health. Even if it’s a small loan or small credit card, as long as you make repayments on time, you’ll start building a strong repayment history, which shows potential lenders that you can manage credit responsibly. That healthy credit history will be an asset when you want a larger loan, for example a car or home loan, further down the track.”

Obviously, be careful. It’s wise to put payments on autopilot.

Experian analysed more than 9 million credit card holders and found those with two credit cards were 54 per cent more likely to miss a payment than those with one. The most likely group to miss payments were 25-44-year-old middle-income earners.