Your credit score is an automatic, computer-generated assessment of the risk of your loan application.
In Australia, it’s specific to each lender so your chances of home loan approval can vary greatly.
So how does your credit score work and how do lenders calculate it?
What information is used to calculate my score?
Your home loan application contains a huge amount of data that the lender can use to assess your situation.
The banks do not specifically publish the exact algorithms and information that their system uses to calculate your score. They prefer to keep this a secret to stop people “gaming” their system.
However, many of our staff are ex-credit officers who have worked for a major lender and have an excellent understanding of how bank systems work. As a general rule, the following information will be used to calculate your score.
Equifax credit history
If you’ve applied for too many loans recently then you will have a high number of “enquiries” on your file, which will lower your score.
Any blemishes such as a default, court judgment or bankruptcy listing will have a significant negative impact on your credit score.
Your credit history or credit file is the single most important factor used to calculate your credit score.
This file is held by credit reporting agency Equifax, which used to be Veda Advantage.
Your history with the bank
If you’re an existing customer of a bank then their system will search all of your accounts, credit cards, personal loans and home loans and will count the number of times you have overdrawn an account or been late with a payment.
Having just one or two missed payments in the last 12 months is enough to result in your loan being declined. Most banks do not share this data with other banks.
The bank’s system will assess how long you have lived at your current address and how long you have been in your job for.
People who have been less than six months in their job, or living at their current address for less than six months, will have a lower credit score.
Your asset position must “make sense” when cross referenced with your income and your age. High income earners with no assets will have a lower score.
If you have saved a significant amount of money then this will have a large positive effect on your credit score.
Lenders are well aware that people with several unsecured debts such as credit cards and personal loans are a higher risk than people who have few debts. In particular, people who have more debts than they have in assets will almost certainly fail the banks’ scoring systems.
If you can only just afford the debt then you are unlikely to be able to cope if your situation changes. Lenders view people who can easily afford the loan as being a much lower risk.
You can use our borrowing power calculator to see if this will be a problem for you.
Loan to Value Ratio (LVR)
The LVR of your home loan is the percentage of the value of the property value or purchase price that you are borrowing. The lower the LVR, the lower the risk your loan is to the bank.
If you’re borrowing more than 90% LVR then you will need to be in a strong financial position to pass the bank’s credit score.
Larger loan sizes are typically a higher risk than smaller loan sizes. For this reason, if you’re borrowing over $1,000,000, then it will be more difficult to pass the lender’s credit score.
The most common loan purposes ranked from the lowest to the highest risk are purchasing a home, purchasing an investment property, refinancing, business purposes, consolidating debt and undisclosed purposes.
Which has the biggest effect on your score?
Your credit history with Equifax, including your Equifax Score (previously VedaScore), is without a doubt the single most important factor that the lenders use to calculate your credit score.
You can use our credit score calculator to work out which aspects of your situation will be considered to be a high risk by the banks.
Does applying with different banks help?
Many people are not aware that applying for several loans or credit cards in a short period of time has a significant negative effect on their credit score.
People who apply for several home loans at the one time are almost always declined, and wonder why they failed a lender’s credit score.
It’s best to work out which banks you can qualify with and then make just one application. If that’s declined then talk to one of our mortgage brokers by calling 1300 889 743 or enquiring online.
Can I trick the bank’s credit score?
Don’t try to “game” the lenders system by changing the information in your loan application.
If their system identifies any inconsistencies between the information on your Equifax credit file, your supporting documents, their own system and your application, then this will negatively affect your score or will result in your loan being declined.
Do you need help to get approved for your home loan? Our mortgage brokers are experts in credit scoring, and can help you to apply with a lender that does not credit score.
Please call us on 1300 889 743 or enquire online and one of our brokers will contact you to go through your situation.
Do banks profile their customers?
Lenders do not use just one scorecard, they instead use a system which “profiles” customers based on many aspects of their situation.
If you appear to match a profile that the bank believes is a high risk, then your home loan will be declined.
For example, they may use one scorecard for men and another for women. This is because the same data may mean different things for different types of customers.
If a man has had a break in his employment he may be a higher risk than a woman who has had a break in her employment. The woman is likely to have taken time off to have children whereas the man is more likely to have been unemployed.
Do you need help to get your mortgage approved? Call us on 1300 889 743 or enquire online to speak to one of our expert mortgage brokers.
Do banks move the goalposts?
Your credit score is just an arbitrary number, it is up to the lender to decide how much risk they are comfortable with.
If a lender has a low cost of funds and is very aggressive in trying to gain additional market share, then they may set up their scorecard in such a way that the score required to gain an approval is very low.
At other times when funding is tight and the bank is not focusing on residential lending then they may move the cut off point up, declining more of the borderline applications.
Each lender has their own risk appetite which depends on their position in the market and their business model.
They all carefully monitor the delinquency rates of their existing loan book, and should they move outside of the acceptable range, then they will tweak their credit score to compensate.
The problems with credit scoring
The main problem of credit scoring is that the accuracy of the decision depends on the accuracy of the data.
Banks are notorious for making mistakes, their systems are unreliable and have lots of problems with maintaining the integrity of the data that they hold.
The other main problem is that credit scoring is incredibly unpopular with customers, the bank staff and mortgage brokers.
Customers feel that they have not been given a fair go. Often there are mitigating circumstances where an application that appears to be a high risk to the system is actually a low risk.
An experienced credit manager could pick this up right away, however in the harsh world of credit scoring, there is no explanation sought from the customer or leniency given.
How do lenders create their algorithms?
The banks have spent years tinkering with their algorithms to make them as accurate as possible.
The way that banks work out which applications are a higher risk is by monitoring the performance of the loans that they have approved in the past.
The larger banks have sophisticated tracking systems that can create reports on the percentage of particular loan types where the borrower is missing payments, or where they have been forced to repossess the property.
Once they have identified types of loans where the delinquency rate has been high, they then get their risk department to analyse the results and work out why these loans have performed poorly. Often there are several factors at work and the interaction between them can be quite complex.
From this analysis the bank can create credit guidelines. For example they may decide that all mortgage applications to consolidate four or more debts is too high a risk and will be automatically declined.
They may also decide that people consolidating two or three debts will have their credit score lowered. This means that if their income or asset position is strong the loan may still be approved, however if overall their position is weak, then their application will fail the bank’s credit score.
Are you a maths geek?
Lenders aim to create a scorecard, which gives borrowers a different number of points for different aspects of their application. They can also lose points for negative aspects such as a poor credit history. The final total of the points for an application is the credit score.
The actual statistical methods used to analyse the data in the lender’s loan book are often non-linear probability modelling, random forests or CHAID. These mathematical methods of analysis identify links between specific data sets that are often unable to be identified by a person.
The history of credit scoring
In the past, Australian banks have used experienced credit officers to make decisions on loan applications. It is only relatively recently that they have decided to use credit scoring as a method of assessment.
Originally credit scoring was used in the US and UK with excellent results. Our banks quickly adopted credit scoring for credit cards, personal loans and other small credit products where the cost of credit assessment is quite high in comparison to the profit from lending.
The Lenders Mortgage Insurers, Genworth Financial and QBE (Formerly known as PMI), were both American companies and were some of the first financial institutions to use this method of assessment for mortgages in Australia. From there, our major banks began to introduce scoring for home loan applications.
There was significant criticism in the USA that their FICO scoring system was relied upon too heavily when approving loans and that this was a contributing factor to the sub-prime crisis.
We believe the FICO score itself is quite accurate, and it was the lenders’ use of it that was the problem.
The unfortunate truth
As mortgage brokers, we don’t like seeing our customers’ applications assessed by a computer. However, the unfortunate truth about credit scoring is that it’s incredibly accurate at predicting how likely a customer is to default on their home loan.
That is why lenders are hesitant to make an exception and override a decision made by their system.
The great news is that not every lender uses credit scoring!
If you need help to apply with a lender that can accept your situation based on its merits then please call us on 1300 889 743 or enquire online and one of our mortgage brokers will give you a call to discuss your options.