What a Credit Score is and why it matters

Musa and Chinwe, colleagues at a fast-growing technology firm approached a bank for loan. Chinwe wants N2 million and Musa, who has personal savings of N1.5 million, wants only N500,000.

Musa and Chinwe, colleagues at a fast-growing technology firm approached a bank for loan. Chinwe wants N2 million and Musa, who has personal savings of N1.5 million, wants only N500,000.

As members of the research team, the techies are on the same pay scale but need a loan to fund the same kind of project. Both loan seekers say they would repay in exactly a year.

Surprisingly, the loan officer says the bank would lend to Chinwe at 15 percent interest rate but would only be willing to oblige Musa at an interest of 25 percent.

Musa, crest-fallen, wonders if he would be afford the high cost of borrowing, and worse: why the bank was “unfair” to him. Musa does not know he has a low credit score.

A recent trend among banks, following directives from the Central Bank of Nigeria, has been the introduction of new products offering loans to fund your education, grow your business and support you in every way.

Even though banks are seeking to lend more, lenders are still cautious of potential defaulters and bad business ideas that are a waste of cash.

The Governor of CBN, Godwin Emefiele in July advised banks to mitigate credit risk and de-risk financial market via the creation of viable credit scoring system similar to what applies in developed countries.

In case you are wondering what the CBN chief was talking about, here’s a guide:

What is Credit Scoring?

Credit scoring is a system used by lenders in determining whether to lend to you and at what rate. In other words it is an analysis lenders perform to ascertain your credit worthiness by assigning points to a number of criteria including past credit records.

Credit score ranges between 300 and 850. A scoring range between 750 and 850 is considered as superb, 500-649 average and less than 499 poor.

There are a number of credit scoring systems but the Fair Isaac Corporation (FICO) system and similar ones are the

most widely used.

How FICO works

FICO is a Us-based data analytics company that uses algorithms to determine credit scores. A quick check by Businessday suggests Nigerian credit bureau companies fashion their scoring system after FICO.

Although credit bureaus in Nigeria adapt FICO to suit domestic market need, the understanding of how the credit scoring system typically works provide useful information to borrowers.

FICO assigns 35 percent weight to person’s payment history, 30 percent to Amount owed relative to credit limits, 15 percent to length of credit history, 10 percent for Frequency of New Credit and 10 percent for Credit Mix.

Information about a person’s transaction history can be gotten in a credit report.

Payment history is trend analysis of how you pay bills. Do you settle obligations as when due? Do you default? When last did you default and how much?

One thing however is payment history only reflects more recent transaction of say 7-10 years and not lifetime financial information.

For amount owed relative to credit is simple debt to credit ratio. The bank wants to see your credit utilization or how much credit you are using compared to how much you have.

If you use a credit card for example, FICO would factor in how much you have used up compared to the allowable limit. It is advisable to keep debt to credit below 50 percent.

Length of Credit looks at how long you have say, your credit card, and how you have kept to deadlines in repaying debt.

Frequency of new credit is important because the more debt one takes on, the higher the person risks defaulting. For instance you would be concerned when someone you recently gave a loan goes around looking for more money to borrow.

A mix of different type of credit shows that the person seeking a loan is able to handle different types.

Why it matters

Going forward Nigerian Deposit Money Banks would be giving out a sizable portion of their deposits as loans, by CBN regulations. This means lenders would have to find a way of knowing who the right candidates for credit are.

In other words, your ability to buy that dream house, fund your business, pay for your education and finance other needs through credit might depend on what statistical analysis of your transaction history say.

Credit scoring is a system used by lenders in determining whether to lend to you and at what rate. In other words it is an analysis lenders perform to ascertain your credit worthiness by assigning points to a number of criteria including past credit records