5 min read

Credit scoring: how fintechs are raising the bar

Amy Gavin

Credit scoring has long been a topic shrouded in mystery; its secrets closely guarded by lenders and credit bureaus. That could be about to change.

The very nature of the credit scoring industry has made it a space ripe for disruption, and fintechs are rising to the challenge. But can they really improve transparency in a market renowned for keeping consumers in the dark?

What is a credit score and why does it matter?

A credit score is a number representing an individual’s creditworthiness or probability of default. It’s important because it plays a major role in how likely you are to be approved for credit, including mortgages and credit cards. Ultimately, the higher your score, the more financially trustworthy you’re considered to be by the gatekeepers of credit: the banks and credit card companies.

Ok, so I want a high score. Who do I have to impress?

Well, unfortunately, it’s complicated...

Credit scores are based on data. Data about you and your finances, past and present. Historically, there’s been a lot of confusion around what’s actually included in scoring models. Dodgy postcode; student loan; criminal record? None of these will affect your score. But it’s often unclear what does.

In both the UK and US, lenders have relationships with powerful companies called credit bureaus (or agencies), which gather and store consumer information from various sources. It’s a concentrated market, with 3 big names holding all the cards: Experian, Equifax and TransUnion (prev. CallCredit). Using their data, lenders hope to minimise risk by only putting money into the hands of ‘trustworthy’ customers. The issue with this is that their secret algorithms are inherently biased, with key factors weighted differently depending on the model.

What the heck do the numbers mean?

The answer to that will depend on the scoring model. Each agency uses a different max score: Experian score you out of 999; TransCredit out of 710 and Equifax, 700. Furthermore, different lenders subscribe to different bureaus. This means that although your credit application might get rejected from one, it’s not uncommon to get accepted by another.

A lack of universal score means that in order to get a true picture of your creditworthiness, you’ll need to collect scores from all three. Feels like a lot of effort. And that’s before you’ve even started the lending application…

Who’s losing out under the current system?

Basically, anyone without a credit history. If your file is blank, good luck getting the banks to stump up any cash. Lenders favour those with a solid history of borrowing (and making timely repayments), which doesn’t exactly seem fair. Innocent until proven guilty, right?

One exciting area of innovation focuses on the key factors included in scoring models across the industry

The system is also disproportionately weighted against the young. Stats from Experian show that younger people generally have the lowest credit scores, mainly due to a lack of credit history. Not helpful when you’re in your prime spending years; looking to fund that house, wedding, round-the-world trip… (and guilty trainer habit).

Another group perceived as high risk is the self-employed. Tricky for freelancers and small business owners looking to borrow to scale-up. And god forbid you’ve got any skeletons in your closet. That mobile phone bill you forgot to pay two years ago could haunt you long into the future when it comes to your credit score.

The good news? Someone’s got your back

Enter, the fintechs. It’s taken a while, but we’re starting to see a real shake-up of the market, with a variety of new players bringing some pretty tasty ideas to the credit scoring table.

One exciting area of innovation focuses on the key factors included in scoring models across the industry.

Rent payments, despite being a major outgoing (headache) for a growing number of us, have traditionally been excluded from credit reports as an indicator of creditworthiness

Not anymore. CreditLadder is a tool enabling customers to use on-time rent payments to improve their Experian credit score. Through partnering with lenders, including Nationwide and Starling, they’re making credit more accessible for those yet to make it onto the property ladder. A long-awaited nugget of good news for generation rent!

Innovators are now looking to take on the credit bureaus themselves

Challengers, such as Lenddo and Zest Finance, are also experimenting with using non-traditional data to calculate risk. As part of their mission to build scores for the unscorable, these fintechs leverage AI-based tools to assess potential borrowers based on financial behaviour that sits outside of typical credit bureau reporting. For example, buying a car at an independent dealer or shopping with a prepaid debit card.

In China, social credit scoring is an alternative concept being rolled out on a massive scale, mainly driven by the fact that only 25% of the population have a credit history. Ant Financial, payments arm of e-commerce giant Alibaba and the world’s highest valued fintech, has built one social credit system to rule them all: Sesame Credit. A whole host of non-traditional variables, ranging from online shopping habits to social media posts, are incorporated into its top-secret formula. Individuals, and their creditworthiness, are judged accordingly.

But is this a step too far? Well, it’s undoubtedly a bit creepy. Enabling access tocredit for those with a limited history is important, but it’s also essential to recognise where an inclusive system becomes intrusive. Big data is a tool that must be used with caution.

Another area under scrutiny from the fintechs is credit score accessibility. Instead of signing-up for a £14.99 monthly subscription to Experian (you can probably think of better things to spend your money on), mobile apps from the likes of ClearScore and WalletHub let you check your score and report for free.

Credit Karma, one of 2019’s fastest growing fintech startups, offers various free tools including a credit score simulator. This clever little feature enables users to instantly see how credit choices, such as applying for a new credit card, might affect their TransUnion and Equifax scores.

New propositions are finally empowering consumers and encouraging lenders to question scoring model assumptions

Consumers can further benefit from how frequently these apps are updated. Traditionally, changes or corrections could take up to six weeks to appear on your credit report. Considering that over 1/3 of people find mistakes on their credit report when checking for the first time, that’s pretty frustrating. In contrast, Credit Karma refreshes weekly and WalletHub daily, providing you with a more up-to-date picture of your creditworthiness.

Not content with just playing on the outskirts of the industry, innovators are now looking to take on the credit bureaus themselves.

Credit Kudos is the new challenger bureau using financial behaviour to provide a fairer representation of creditworthiness for individuals and businesses. Through new Open Banking rules, Credit Kudos can connect with all major banks to securely access your financial history and factor this into real-time credit decisioning.

They’ve recently partnered with Cybertonica, a machine learning and AI platform, to incorporate biometric and behavioural analytics e.g. mouse movements, into their scoring model. Cybertonica’s new ScreenWize tool takes transaction data to the next level in a pretty cool way; advancing application scoring for both applicants and lenders and significantly speeding up the process.

The sensible bit

Innovation is all well and good, but credit scoring has, and always will be, a bit of a sticky subject. Scores exist for a reason. They’re not just about ensuring people who should be getting access to credit can get it, but also protecting those that shouldn’t be borrowing from getting into financial trouble.

As the industry evolves, fintechs and incumbents must work together to ensure the FCA’s responsible lending rules are not forgotten; putting customers at the heart of innovation whilst ensuring that no-one is biting off more debt than they can chew.

What does the future look like?

The future’s bright! Fintechs are exposing the cracks in the credit system and reshaping our financial expectations. More inclusive, personalised and fair? Yes please.

New propositions are finally empowering consumers and encouraging lenders to question scoring model assumptions. Issues around algorithmic transparency persist, but awareness of what does and does not affect your score is growing at pace.

The regulator is doing its bit to increase competition in the industry, having recently blocked Experian’s £275m acquisition of ClearScore on the grounds that it would dis-incentivise innovation in the market. But how far new players will succeed in challenging the dominance of the big credit bureaus remains to be seen.

Ultimately, if the credit system is to be truly (and responsibly) revolutionised, the pressure needs to keep coming from the fintechs. Hold tight and watch this space; credit scoring is about to get very interesting.

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 Amy Gavin
About the author

Amy Gavin

Amy is part of the 11:FS Research & Benchmarking Team, responsible for investigating key fintech trends and providing expert industry analysis.

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