How does credit scoring work, and how can open banking help?

Credit scoring is the process of determining if a person or institution is capable, or worthy, of taking up a loan and repaying it. This is achieved through statistical analysis of the information on a credit report, which usually translates to a numeric score. 

However, although it may not seem like it, your credit score is more than a formula that evaluates if you are capable of getting a loan or the interest rates you might have to pay. 

A credit score is a broad financial tool, and the better score you have the greater deals on loans, credit cards or insurances you can get. On the other hand, a less favourable credit score can have you pay more or even limit your growth opportunities.

How is a credit score calculated?

A credit score might be calculated by different bureaus, depending on where you are located. 

Generally, a credit score is defined by a system that allows lenders and financial institutions to determine your creditworthiness. There are a lot of criteria taken into consideration when determining this value for an individual, as you can find below:

• Income: do you earn enough money to pay back the money you are asking for?

• Payment history: do you have a track record of paying your debts in time? 

• Length of time using credit: how long have you been using credit?

• Type of credit: what types of credit do you access? 

• New credit: how many credit accounts do you have? 

• Amount and types of debt: how in debt are you? Can you handle what you owe?

If you are running a business, chances are that you at least considered borrowing some money to take your project to the next level. This is particularly true for small and medium-sized businesses that look at loans as a sustainable way of keeping up with the competition and bringing new products to the market.

However, a business credit score is not the same as a personal credit score. The criteria to assess a small business’ credit score are somewhat different. A company’s credit score heavily relies on information from its credit report. For example:

• General company information (sales, subsidiaries, number of employees, etc)

• Industry classification

• Business registration details

• Historical business data

• Payment history

Additionally, they rely on different rating agencies, with personal credit scores usually ranging from 300 to 850, while business credit scores usually vary from 0 to 100. Business credit scores also obey their own standards and formulas.

What affects a business credit score?

• Revenue: how much does your company make in a year? The more, the better.

• Assets: what assets do your company own? Owning property, for example, is a huge plus.

• Longevity: how long have you been in business? If your business has been around for a while, the better its chance of a good credit score.

• Industry risk: some industries are riskier than others. 

• Debts: do you have other loans? Are you paying them off in time? This is a huge factor for lenders. 

• Loan/Credit history: do you have a personal and business credit history? For how long? History is used to avail how likely it is for you to pay back loans in the future. 

• Public records: have you had any legal judgements against you or your company? 

At the end of the day, it’s all about risk. Lenders and other financial institutions apply these methods to determine how likely it is for them to lend money to a person or business and get repaid. 

People or businesses with good credit scores will have easier access to loans, probably benefiting from lower interest rates and extended instalments. 

Those who have bad credit scores are going to have a harder time accessing loans. Since they are considered a riskier client, they will probably be charged more interest, have reduced instalments, and maybe even get their applications flat out rejected. 

As you can see, credit scoring has a great deal of impact in your financial life. From small things, like buying a new smartphone or a home appliance, to renting a new home, everything might depend on how well rated you are as a borrower. 

This number can save you a lot of money, and even put you in a more favourable position to make your dreams come true or get ahead of the competition.

But it can also cost you a lot of money if you are seen as a bad actor. To avoid this, don’t forget to make sure your credit score is as high as possible, so you don’t have to face any unpleasantness and have more opportunities to grow.

How can you improve your credit score?

Maintaining a good credit score might not always be easy, especially when you are just starting out, but it’s totally worth it. After all, a good credit score puts you in a better position to get the best deals. 

Here are some suggestions on how you can boost your chances of getting a good credit score and that much desired loan:

• Make sure every bill is paid in time: no one likes people who don’t fulfil their promises and legally binding contracts;

• Consider taking up a loan, even if you don’t really need it right now: but only if you are absolutely sure you can manage to pay it back. Credit/loan history is a great way of providing rating agencies with the necessary tools to track your record of taking debt and repaying it;

• Do not miss payments and take up too much debt: these are huge red flags for prospective lenders. Show them you are able to control your finances; 

• Make sure you are using your credit card regularly, but carefully: use it enough so that it can vouch for you, but always control your spendings;

• Improving your daily habits: practise good financial habits every day, from the grocery store to business expenses;

How can open banking help?

Open banking can also help, by reducing the stress associated with creditworthiness — digitising processes, speeding up the application processes, and offering a new and improved customer experience. 

Open banking credit scoring solutions also provide lenders with valuable data that allows them to make better decisions, levelling the competitive playing field. 

This new technology is also behind several tools that promote financial literacy and a greater control over one’s personal finances. Personal Finance Management (PFM) applications can have an amazing impact on how we look at all things money related.

They provide us with the many necessary tools to learn how to build up good habits and a great credit score — from tracking spendings to detecting patterns that we can use to improve our odds. 

The impact of open banking on credit scoring

Customers with little credit history are at a greater risk of being denied access to credit, something that can hold back their perspective about success. 

Open banking enabled credit solutions leverage banking data to give prospective lenders and other institutions all the information they need to improve their risk assessment and creditworthiness — accessing financial data, like payments and income, in real-time.

Lending decisions are now more complete by combining these new methods with legacy processes, benefiting those who need an opportunity to grow, not forgetting fraud prevention via Strong Customer Authentication (SCA), which reduces the risk of document falsification.

Open banking allows all this to be done in a more transparent way, with improved data quality that translates into a more accurate credit scoring.