Whilst every lender checks whether a customer has a history of repayment as part of creditworthiness assessment, but whilst inflation might be slowing, prices remain high, meaning lenders are more focused than ever on understanding if consumers can afford to take on credit.

In a recent Equifax industry survey, 22% of financial services companies told us complying with consumer duty was the number one challenge they face in assessing affordability1. In the same survey, almost a quarter (24%) of respondents told us the rising cost of living was top of the agenda1. 

Assessing affordability has become an increasing priority for lenders. Consumer Duty regulations have emphasised the need for businesses to put in place more robust ways to assess consumer affordability as lenders will need to focus on good customer outcomes.

And this is why we’ve built Affordability 360. To provide our clients with a complete view of a customer’s income and expenditure, using a combination of datasets to provide the most comprehensive and accurate assessment of affordability.

Affordability assessments have an important role to play

Lenders need to ensure they are not over-burdening customers with credit they cannot afford and could be required to demonstrate why they accepted a credit application, should they be challenged by the Financial Ombudsman Service (FOS).

According to the Bank of England’s Credit Conditions survey Q4 2023,  default rates (and losses) on both secured and unsecured lending (including credit cards) increased in Q4, and were expected to increase further in Q1.  This trend is expected to continue whilst interest rates and inflation rates remain high2.

Lenders that do not change their risk appetite or how they measure affordability, are likely to experience worsening bad rates. They could actually approve more customers by improving how they assess affordability.

How can lenders be confident that their affordability models are still accurate?

Our own industry survey found that

• 24% of organisations relied on a customer's self declaration to assess expenditure1
• 19% rely on a credit bureau as their primary data source to assess expenditure1
• 16% rely on Office for National Statistics (ONS) data to assess expenditure1

The rising cost of living has driven fluctuations in consumer expenditure and there are a range of ways we can help our clients to assess affordability. Equifax is able to extend ONS and Minimum Income Standards (MIS) data for clients seeking to use those data inputs but every data source has its limitations.

Many lenders use their own internal calculators, employing ONS (Office for National Statistics) data as a basis for their own affordability assessment models and factoring inflationary pressures.

Few consumers are likely to fit into the ‘average’ dictated by ONS data. In our own research when comparing essential spending, ONS estimates were 25% higher on average than essential spending we  identified using open banking data3. Expenditure estimates like these will rarely be accurate on an individual level, even when factoring in inflation, largely because consumers adapt their lifestyles and spending habits to accommodate rising costs. 

A more realistic view of expenditure is likely to be found using Open Banking data. But we recommend using a combination of data sets to make the most accurate assessment of affordability.

Why use a combination of data sets?

Relying solely on a customer’s self-declaration is likely to have significant shortcomings. Consumers often have little understanding of what their average spending is month on month. So a self-declaration is at best an educated guess by the consumer.

For affordability measurements, bureau data could be missing key expenditure items like utilities, council tax, mobile phone and  broadband bills, as well as basic living costs (food, clothing and rent). 

Whilst ONS data provides a good benchmark, it's based on information from FYE 2022, so, this quickly becomes unrepresentative and only provides a view of expenditure at a geographical level.

Open Banking offers the most accurate source of expenditure data, but consumers may hold a number of bank accounts or utilise credit cards to make a significant number of payments, which may not be picked up by transaction data categorisation unless they consent to share these accounts too.

This is why a combination of data sets provide the most accurate assessment of affordability.

Making more accurate lending decisions

When assessing affordability a key component is predicting an applicant's current accommodation expenditure. Lenders could be missing crucial accommodation payments. If only statistical information is used to calculate an applicant's essential living cost, there is a danger of underestimating living costs for 33% of applicants3.

Reliance on a single data source may not be accurate enough. Our own analysis suggests that using a combination of data sets that includes Equifax credit information, bank account transaction data (via Open Banking) and statistical estimates from ONS and Minimum Income Standards (MIS) lending decisions that are likely to be 39% more predictive of customer defaulting than using declared income and ONS calculations alone3.

How can Equifax help…

Our new Affordability 360 solution uses a combination of data, which includes bureau data, ONS, MIS and highly accurate transaction data insights accessed via open banking. All delivered seamlessly through a single channel to offer the most comprehensive view of a customer’s income and expenditure.

We’ve built robust algorithms to ensure the best possible source of data on an individual basis is being used to provide the most comprehensive and accurate assessment of affordability.

Book a consultation with one of our Open Banking experts to find out more.

 

 

Sources:

1 Research carried out for Equifax by Open Banking Expo was conducted between 14 July and 5 September 2022. Total sample represents 127 senior decision makers from UK financial services companies.

2 Bank of England - Credit Conditions Survey 2023 Q4

3  Analysis based on a sample of ~ 30,000 applicants who had completed an Open Banking journey. Consumers were categorised as having ‘low affordability’ based  CATO Affordability Index - Non Tier 1 Banding 4.  Customers' performance was marked as 'Good' or 'Bad' based on whether they had defaulted on any financial agreements during the 12 months we observed.