Rating your credit worthiness

New Zealanders will soon be greeted by an advertising campaign promoting credit scores from Veda. Photo / Supplied

The credit check I ran on myself was deflating. I expected a sad and sorry litany of my life on the edge of a financial precipice, a life where the weekly pay cheque is but a burp for the insatiable beast of indebtedness.

But the credit file from reporting bureau Veda Advantage gave no real hint of my chronic impecuniousness. No defaults, no insolvencies, no judgments, not even a stolen identity. Just seven inquiries in the past five years by lending institutions - one from the finance company which funded the now rickety lounge suite and the others from the bank to which I am eternally indebted. No doubt the bank was curious about my increasingly frequent bids to raise the bar on my overdraft.

But here's the thing. Those finance providers know more about my financial plight than they would learn from a credit reporting bureau. The form you fill in when you apply for credit elicits much more detailed information than the data which the reporting bureau (the agencies once known as debt collectors) can legally hold.

The finance company, for instance, wants to know about your income and all your other debts, [as well as] dubious assets like the fully depreciated car. But under current laws, the reporting bureau holds only information that demonstrates you've gone off the edge, such as defaults on payments, bankruptcies or court judgments. This is known as negative reporting - a system used in New Zealand and Australia but in few other Western economies.

Veda Advantage (formerly Baycorp) scored itself a publicity coup this week by announcing its new credit score service, where it rates lenders' creditworthiness on a scale from minus 330 to plus 1000. Veda, it turns out, is far from alone in calculating a score to simplify judgment calls for their clients (who include finance companies and businesses) - banks and insurance companies do it too, while rival Dun & Bradstreet scores individuals in Australia.

But how useful are credit scores based on the usually scant negative information which reporting bureaus are allowed to hold and pass on? Veda's managing director John Roberts says 75 per cent of debtors on its files have no adverse information about them. And while the file will list inquiries made by financiers, it won't show whether the loan proceeded or not.

The announcement (scores will be available from August 2) brought a predictable outcry from those concerned about their freedom to keep schtum about their finances. Feedback on the Herald website included a fair few who railed about the spread of Big Brother and worried that the information could be passed on to employers and otherwise held against them. Some predicted the emergence of a tiered society, with second-class citizens forced from the workforce and, like The Prisoner, dogged through life by a number.

While highlighting widespread ignorance of the amount of data gathering that takes place already, what many missed was that applying a score doesn't add anything to the reporting bureau's knowledge of us.

But a credit score will matter more if the bureaus succeed in their campaign to change privacy laws so they can gather and hold more data about us. They want a move to positive reporting - an attractive sounding term which allows them to collect even more information on our wheelings and dealings.

Our society is built on credit. Sixty per cent of GDP comes from household spending, much of it funded on a wing and a prayer. In recent years, sources of credit have broadened from banks and finance companies to money lenders who charge higher interest to those already deemed a credit risk by banks and finance companies.

But as the credit crunch shows, lending money to those who cannot repay can be damaging not just for lenders but for whole economies. A move to positive reporting, also known as fuller or comprehensive reporting, is billed as giving a better picture of a debtor's ability to repay - and therefore good for both lender and borrower.

It comes with the lure of cheaper interest charges for borrowers with high scores - an incentive for people to actively manage their credit files to improve their rating.

In practice, this could also mean finance companies inflate their charges to anyone with damaging information on their file - and Veda's statistics suggest one in four New Zealanders have.

Auckland University business school senior lecturer Gehan Gunasekara told the Dominion Post that fuller reporting would push more people deemed credit risks to look elsewhere. "There's always someone who'll lend to those people - they'll get shipped down the list to the loan sharks."

The Privacy Commissioner's Office is reviewing the credit reporting privacy code and the report of a working party of industry and consumer representatives is with commissioner Marie Shroff.

In the United States, credit scores which can be accessed by employers and landlords as well as money lenders have spawned a whole industry of hangers on. Firms have sprung up offering to help people improve their credit rating - for instance, by calling themselves a director when they mow lawns for a living. A high credit score attracts lower interest on finance - but it can also make them more attractive to identity thieves.

As online Herald readers in the US have reported, careers can be damaged by low scores sometimes based on wrong information which is hard to correct. And you can be marked down for reasons as innocent as a lack of credit history (tough if you're a student or new immigrant) or frequent changes of address. People with similar, or the same, names are often sullied with others' defaults.

While fuller reporting widens the scope for errors, Roberts notes that even with negative reporting a minority of people find things on their file which they think shouldn't be there.

Historically, New Zealanders have shown little interest in managing their credit file, he says, taking interest only when they are refused credit.

John Scott, general manager of Dun & Bradstreet, points to research claiming that more comprehensive information will reduce discrimination and increase the chances of women, young people and new migrants getting mainstream credit. While fuller reporting may be expected to lead to a tightening of lending, the research indicates the opposite - lenders have greater confidence in most consumers.

Scott says fuller reporting also discourages credit surfing - obtaining loans from other sources to pay existing ones.

The current regime means lending institutions have a lot of positive data - such as faultless repayment records - which they are not allowed to share. "Informed debate is needed because a lot of people don't understand what is involved."

Justin Kerr, executive director of the Financial Services Federation, says fuller reporting should mean recidivist defaulters are stopped from getting themselves into even more debt.

"It's a matter of balancing the economic benefits and privacy concerns to ensure there's an advantage for individual consumers as well as lenders."

Kerr says people are sometimes needlessly penalised for defaults. "If a person has had five or six credit accounts over five years and managed them all without a problem then that one default can be assessed against the bigger picture. There may have been perfectly understandable reasons for it."

Assistant privacy commissioner Blair Stewart says one reason for considering fuller reporting is increasing automation in the finance sector, "which means machines are making decisions and they are reliant on what's in the database".

He can see benefits for both sides in having a fuller picture of what he calls the credit cycle - the ability to repay what you've borrowed in the time allowed.

"As the law stands, arrangements you make with your bank or finance company remain confidential. If you then go out and borrow from someone else that can affect your ability to repay the bank loan."

He says while the finance provider can ask about your other debts the reporting bureau can't. "And individuals can lie in seeking credit, so some degree of verification is part of the process."

Stewart says there's good evidence supporting the economic benefits of positive reporting but "some cultural and social issues as to what's acceptable in New Zealand society to pool and share with others". There's no need, for instance, for all New Zealanders to have their incomes recorded on a database.

But portraying New Zealand's system as negative and out on a limb is a bit misleading, he says. The current system allows not just negative data but information about directorships, occupation and employment history.

The commissioner's office is waiting to see how the Australian Government responds to a recommendation of its law reform commission to introduce fuller reporting. The two countries share not only similar reporting systems but the same banks, finance and credit check companies. If New Zealand does move to fuller reporting, the first steps are likely to be tentative, he says, with limits potentially placed on what information employers or landlords can access.

Stewart is conscious of overseas reports of the obstacles to having inaccurate information corrected. Agencies have shown a reluctance to release details of how a number is arrived at, claiming it is proprietorial information.

In this country, finance companies have occasionally been reckless about the information they circulate, particularly in disputes. "If people are assigned a number a major challenge would be ensuring there is transparency about how the score was obtained and how it could be challenged."

What information can credit bureaus obtain now?

* Identification, including full name, address, occupation and employer.
* Applications for credit including amount sought and type of credit.
* Credit defaults, including total owing.
* Court-ordered repayments.
* Insolvencies and bankruptcies.
* Public register information, eg: directorships.
* Lost or stolen identification.

What extra data are they seeking?

* Whether and when the account was opened and closed.
* The credit limit.
* Whether repayments are made on time and any arrears.
* Ability to use driver's licence number as an identifier.

Factors that can negatively influence your credit rating:

* Payment defaults or overdue accounts.
* Stolen identity.
* High mobility.
* Large number of lender inquiries.
* Type and large amount of credit sought.

What can be done to improve your rating?

* Pay bills on time.
* Pay credit card balances in full.
* Consolidate debts.
* Only seek credit when you really need it.
* Alert loan provider to repayment difficulties.
* Acquire a solid credit history.

HOW YOU GET RATED

How do credit agencies rate us under the current "negative" reporting system? Veda's John Roberts says there's reasonable confidence about the scores his company plans to ascribe to us.

Age is a guide. "Young people tend to be a bit gung ho and can be a higher credit risk than someone who's middle aged."

Frequent inquiries by loan providers can indicate "credit stress" (though it could simply mean someone is shopping around for the best deal on that plasma TV).

Frequent moves over a short period could suggest someone trying to evade creditors.

The algorithm-based calculation is "highly predictive of the likelihood to pay or not pay compared to the population as a whole," says Roberts.

But the narrow range of information currently held can be misleading. In the past, frequent inquiries by a telecommunications company might have indicated the person was a credit risk. Now it could simply reflect a younger person changing plans or models in response to offers, or adding the latest gimmick.

"People's financial behaviour has changed significantly between baby boomers and generation Y."

He says Veda's system will take such differences into account and distinguish between a serious payment default and a $20 video library fine. "There's a lot we can do but it will never be as predictive as if we have comprehensive reporting."