Credit scores were the final word on what a customer can afford, but they are rapidly becoming just one tool in the box. Chris Farnell reports.
The motor finance industry makes wide use of credit scores to assess the risk of lending to specific customers and companies. Credit agencies are a critical resource for lenders to protect not only themselves but also to ensure customers are not placing themselves under undue financial strain.
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They are a vital part of the automotive finance sector, but what about the parts that credit scores can’t reach? Are customers, dealers and lenders alike missing out simply because they don’t have the right information?
When it comes to the automotive industry, the way it uses information from credit reference agencies is very similar to other industries, assessing how likely people are to be able to manage repayments for financial products.
As well other sectors, lenders share information on their customers’ payment behaviour, which is then added to other useful information such as court judgements and the electoral roll, to help organisations understand people they may not have worked with before.
The automotive sector has also faced a lot of the same issues as other industries as the regulatory environment has evolved.
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By GlobalData“In recent years, guided by the regulator, there has been an increased focus in all industries on the affordability of financial products offered to consumers,” says Gerardo Montoya, managing director of automotive at Experian. “They must be affordable throughout the lifetime of the loan.”
However, the industry also has its own unique challenges. Experian has a specialist unit devoted to automotive finance, working alongside the automotive industry much more than credit checks.
“As well as provenance checking vehicles, we help companies improve their digital customer processes, so there are less awkward conversations for customers and help guide them on trusted trade-in prices,” Montoya says.
While most people will immediately think of their credit score when you mention Experian, Montoya explains that the agency is finding new ways to create a portrait of customers’ financial health.
“Lenders are using a more comprehensive range of data sources, including Open Banking, to see bank account transaction data, to get a greater understanding to make high quality and profitable decisions,” explains Montoya.
Credit Through the Pandemic
While this evolution of how lenders and credit agencies use data was already taking place, it has been accelerated by the unique pressures of the Covid-19 pandemic.
“There can be no doubt the Covid-19 pandemic has been challenging for the automotive industry, and our work is focused on finding the best way forward with our clients,” says Montoya. “If there is a positive to come from this difficult time for motor traders, many have enhanced the digital journeys they can offer to customers.
“The proportion of a car purchase people are willing to carry out online has increased. We’ve seen the growing presence of online-only traders with national advertising campaigns, but we are also working with ‘traditional’ motor traders to improve their customer experiences. This includes everything from pre-qualifying people for car finance to avoid disappointing customers, to providing the most accurate trade-in valuations using real-time data.”
In responding to the Covid-19, pandemic credit agencies are helping the motor finance sector to provide a seamless journey for customers while also protecting traders from fraudsters by ensuring people’s identity is verified before a vehicle is handed over.
But the response to the pandemic has necessitated more than easing online transactions, as Montoya tells us: “Early on in the pandemic, Experian and the other main credit reference agencies decided to put an emergency payment freeze in place due to many lenders offering payment holidays. As a result of this, credit scores have not shown significant changes.”
The need to support borrowers through the crisis has been emphasised by the FCA, who responded to the beginning of the second lockdown in November by extending mortgage payment holidays and announcing support to other affected borrowers, proposing to extend payment holidays to mortgage, loan, credit card, rent-to-own, buy now/pay later customers, and of course, motor finance.
The proposals amounted to two payment deferrals up to a total of six months for those who haven’t already received one, with the option of requesting an initial payment referral any time until the end of January this year.
What’s more, these payment holidays would not be taken into account in borrowers’ credit scores. While this is good news for customers, credit agencies are expanding their repertoire of information sources when assembling a picture of borrowers.
“It’s not only credit scores which lenders are using to understand the financial situation of prospective customers,” Montoya points out. “They are using new data sources – such as Open Banking which allows them to view bank account transaction data – to get a greater understanding so they can make higher quality decisions.”
‘Invisible’ customers
This means that while payment holidays resulting from the pandemic may not be directly visible in a customer’s credit history, other sources of information may still fill in the gaps.
The FCA has confirmed lenders are able to do this, saying: “In practice, lenders may use sources other than credit files, such as bank account information, to take account of other factors in their lending decisions. These factors could include changes to income and expenditure, and also any increased indebtedness as a result of interest accruing during the payment holiday.”
Indeed, this trend was already progressing long before anyone had even heard of Covid. When we spoke to Experian in 2019 they explained that credit agencies were expanding their capability to reach people who might otherwise be “invisible”, such as using information such as tenants’ records to show a history of regular payments where there is no formal credit history to draw on.
“Credit reference agencies such as Experian are able to provide lenders with an understanding of how a large majority of people manage their repayments, so they can make informed decisions. However, our research found there were 5.8m people in the UK who are ‘credit invisibles’ because there is little or no relevant financial information available on them for lenders to make a decision,” Montoya tells us.
“We have been working to reduce this number. That means it’s difficult for them to access mainstream financial services, so they often end up paying over the odds or get turned down when more information may show they are reliable and responsible with money.”
Bringing these customers into the fold isn’t just good news for the customers themselves, it’s also good for business.
“For organisations such as motor traders, the cost of not being able to make informed lending decisions is often lost business,” Montoya points out.
Risk and Reward
These insights will grow increasingly important in light of new FCA rules regarding price models. While many dealers may prefer to retain single rate or banded pricing models, pricing mechanisms are evolving and some consider a shift towards risk-based pricing is inevitable.
As MotoNovo Finance chief executive Mark Standish says: “While I understand the simplicity appeal of a single rate or banded pricing model for finance; for me, the risks to the future of dealer finance heavily count against it.
“I know I am not alone and we are seeing momentum getting behind risk-based pricing from the lender community. While some lenders might start the forthcoming regulatory environment with a fixed-rate model, there is an expectation that a number are planning to move to risk-based pricing as they conclude their development work.”
The broader operating environment in the motor retail sector has changed significantly in recent years, but dealer finance pricing has remained unusually static. Customers will often be offered a “one size fits all” rate that is not tailored to their individual circumstances and can lead to them paying a higher rate.
As the automotive sector is working towards further digital and frictionless selling, this approach is looking less and less sustainable when price comparison sites are easily available and dealers and lenders have access to increasingly robust personal credit data information.
Risk-based pricing
The risk-based pricing model has yet to gain widespread traction in the dealer finance section. The barriers to a risk-based model are a combination of technology and the challenge of verifying the risk model to account for individual and vehicle risks, as was, simply, the magnitude of the change.
But some companies, such as MotoNovo, have advocated the advantages of this approach. This is why MotoNovo launched “MotoRate”.
“Embracing change is part of our culture,” Standish says. “While change can present risks, in this case, the risks of not changing, even in the short term, looked far higher. From a regulatory, technical and above all customer perspective, we concluded that for the future well-being of dealer finance, the connection between the borrower and their risk profile had to be recognised.”
The single rate pricing model will appear particularly unappealing to the customers lenders are keenest to have- the prime credit quality audience who will be paying more than they could because the price takes into account higher-risk customers.
A single price needs to reflect the audience of people taking finance, and without that prime audience, the implication is that price at an individual and overall APR level could well be higher than it might have been. This, in turn, could have long-term implications for the dealer finance model and its reputation.
Rather than seeing dealer finance risk such a slippery slope, Standish is confident that the opportunity afforded by risk-based pricing is to welcome a broader pool of customers to the unique benefits of dealer finance, increasing market share. It’s an approach back up by MotoNovo’s results. Finance volumes from over 2,000 dealers embracing MotoRate have grown over 70% new business year-on-year.
“Risk-based pricing for us was not a quick fix. MotoRate was two years in development and it is why we expect a trend to risk-based pricing to emerge as other lenders develop their infrastructure. Right now, we are well-placed to help dealers to benefit from that ‘early mover’ advantage,” concludes Standish.
To successfully grow the automotive market and motor finance sectors the industry needs to be accessible to the full spectrum of customers, from the cream of prime customers who may by unfair pricing, to sub-prime customers or those without a credit history.
“It’s Experian’s mission to reduce the number of people who are financially disadvantaged in this way to zero,” Montoya says. “We’re tackling the problem in two ways. We’re encouraging companies to share data on their customers with Experian and other credit reference agencies so organisations can easily identify them and make better decisions.”
A win-win scenario
Of course, just as credit agencies and lenders can become ever more informed about their customers, customers are increasingly more informed about their own credit and what it means. This creates opportunities to collaborate with the customer and empower them to improve their own credit.
As Montoya tells us: “It’s also possible for people to instantly improve their credit score for free by signing up to Experian Boost, which we launched last year. They can contribute information on the regular payments they make for video and music streaming services, as well as council tax payments, to boost their credit scores. Boost’s launch has been popular with people, which suggests their willingness to understand and actively improve their credit scores has increased.”
It demonstrates that when customers are given the information and the tools to build a strong credit profile, they will be proactive about doing so.
By providing these tools, and creating more transparency around the credit scoring system, it’s possible to create a win-win scenario for customers, credit agencies, lenders and dealers alike.
