What is a credit score and why is it so important
August 11, 2021
Credit scores not only enable access to credit, but are also the yardstick with which different companies evaluate the type of service they offer to various clients. In this sense, an adequate score can help an applicant get good deals on car purchases, credit cards, telephone plans, insurance policies, among others. Conversely, having a low credit rating can lead to much higher prices or deprivation of the product or service.
What is a credit score and how does it work?
A credit score is an identifying number that shows a person's creditworthiness. Most people don't have just one score, they have many, which in turn change all the time. They are obtained free of charge, since this information works as a risk index for numerous companies or organizations.
Traditional scoring models evaluate credit risk based on the following information:
- Payment history: If payments are made on time, frequency of payment and when were these payments due.
- Credit utilization: How much a person owes on loans and credit cards.
- Length of credit history: The longer the person’s payment history, the higher the score.
- Combination of existing credits and account types: If a person has a combination of accounts; including installment loans, home loans, credit and retail cards.
- Recent Credit Activity: If a person recently opened many new accounts it could suggest potential financial problems and may lower the score.
However, these credit studies are somewhat limited since they are only based on data from people who are within the banking system. Thus, millions of people - trustworthy but outside the banking system - are excluded from the rating models; losing the possibility of not only acquiring a loan, but of also accessing better offers of products or services.
Alternative scoring: a more inclusive rating method
Alternative credit scoring arises from the need to include individuals who are creditworthy, but who for various reasons - for example age or because they prefer to use cash - are unbanked and therefore not rated.
Unlike traditional data, this advanced credit scoring, includes new sources of data related to people's behaviors such as: rental payment and subscriptions, online purchases, social network behaviours, among others. Alternative credit scoring uses artificial intelligence for processing this data and generating prediction models that are more accurate than those from traditional sources.
In recent years, this type of credit rating has become increasingly popular due to the benefits it brings to both the client and the lender:
Greater market reach
Alternative credit analysis offers a new market for companies that are eager to provide their product or service to people who are not yet in the system. These people can now be evaluated based on their payment discipline and behavior, increasing the client base.
Improved customer experience
Through automated alternative credit rating processes, companies can minimize the costs of acquiring a customer and thus reduce rates, making these accessible to prospects.
Better offers for clients
Currently, applicants who receive approvals for loans or services based on past credit information may be subject to higher fees, since insufficient information results in low credit scores, and thus companies rate these prospects as high risk clients. But with alternative credit scoring with real-time data, these prospects have the opportunity to get better deals.
In short, the future looks more promising for potential borrowers. Alternative scoring helps break the exclusion vicious circle, giving people the possibility of accessing a system that can significantly increase their possibilities. Likewise, it allows companies to access new markets and present better offers, reducing risk and making informed decisions.