How to Expand Credit Access with Alternative Data

Access to credit is one of the most important financial tools in America.   With the way credit worthy consumers are determined currently,  however, millions of American adults are left in the dust.  Helping more US consumers obtain access to mainstream financial services requires new insights into individual financial history.  Alternative data (information not found in traditional credit reports) could score up to 90% of the country’s previously unscorable customers.

Who in America currently has a thin or nonexistent credit file?  There are more of them out there than one might realize.  92 million American adults have little to no credit history.  Of that group, 25 million are considered credit invisible, meaning they lack the credit history necessary to establish a credit score.  The lacking in credit history population has a relatively large overlap with the unbanked or underbanked population.  In the US today, 63 million Americans do not have sufficient access to banks.  Many rely on high cost alternative financial services such as check cashing services or pawn shop loans.  

The demographics of people underserved by financial institutions today line up with the demographics excluded from financial services in the past.  Those with little to no credit history are 75% likely to make under $50,000 a year, with 49% making under $25,000 annually.  Beyond income statistics, this group of 92 million Americans are more likely to be Hispanic or African American, recent immigrants to the US, and/or be recently widowed or divorced.  Also included in this cohort are individuals who are young, new to using credit, or have not used credit for a long time.  

Credit invisibility can be costly to the consumer.  When lenders lack sufficient information to determine a borrower’s risk profile, they tend to assume the worst about them.  The interest rates one receives on a loan match their perceived riskiness as a borrower, among other factors.  When a credit invisible consumer goes to borrow money, they could pay a higher interest rate on personal loans.  In the mortgage market, a subprime loan could bring an additional $32,923 in interest compared to an average 30-year mortgage at the prime rate.  Credit invisible consumers are also likely to face higher premiums in the insurance market.  This rule applies to auto, home, and rental insurance.

Borrowing money is something many Americans will have to do during the course of their lives.  60% of Americans could not pay an unexpected $1,000 expense with savings alone.  A third of those unable to pay outright say they would borrow to cover the cost.  Consider how common an unexpected $1,000 expense can be.  Borrowing money at a reasonable interest rate could be the difference between solvency and bankruptcy for an American household.

The solution to credit invisibility is not to force banks to lend to everyone.  Banks need to be selective about the loans they make for a reason.  They have a reason to want their borrowers to be financially responsible individuals.  The problem here is that many financially responsible individuals are not seen by the credit scoring system.  Were alternative data to be leveraged in generating credit score calculations, nearly half of the previously unscorable population could become prime or near-prime borrowers.  Moving over 20 million Americans into scorable credit bands is no small feat.  It would change the lives of people across the country!

What forms of alternative data should scoring agencies look at?  What permissions would they need to access this information?  The 3 alternative data sources identified here are bank transaction data, rental payment records, and telecom and utility bill payments.  All 3 require consumer permission for scoring agencies to use in their calculations. 

The first addition under consideration is bank transaction data.  Credit scoring agencies could look at a consumer’s bank statements to see how money flows into and out of the individual’s account.  An individual who spends quickly and maintains a low balance is less likely to be financially responsible than one who consistently leaves money in their account.  Use of bank transaction data alone could increase prime (or better) consumer numbers by almost 4 million.  Were bank transaction data to be considered for all consumers, the credit unscorable population would fall by 50%.

Next up is rental payment records.  Rent payment reporting is one of the most under-utilized tools for building credit histories.  Many landlords perform credit checks on potential tenants as part of their leasing process, but rental data itself is not included in credit reports.  This omission puts renters at a disadvantage in the credit market next to homeowners.  Both make monthly payments to maintain their access to housing, but only one sees those payments appear in their credit score.  A majority of consumers believe it would be helpful to have rental payment information included in credit reports and factored into credit score calculations. 

The final alternative data source that should be added to credit reporting is telecom and utility billing information.  90% of American adults have at least one utility bill in their name.  Adding this factor to credit reporting would ensure a wide net is cast.  9 million consumers could become scorable thanks to consented telecom and utility data.  Furthermore, people who pay their full utility bills on time show that they are financially responsible.  Adding telecom and utility data to the mix could move 7.5 million US consumers from unscorable or subprime credit bands into prime or near-prime categories. 

While credit reports remain a strong indicator of credit history and past financial reliability, there is an abundance of Fair Credit Reporting Act (FCRA)-compliant information that is not currently used to generate credit scores.  Including this information has the potential to responsibly expand consumer access to credit and support a more inclusive economy.  Credit is used for many purchases in the United States, from homes to higher education.  Reasonable credit terms at the right time could be the break an individual needs on their path to financial prosperity.  Alternative data is there to help.

Equifax expands access to credit with alternative data