What is alternative credit data?
Your credit score is one of the most important numbers in your life. Every time you want to access capital - whether it's to buy a house, or start a business, or just open a new bank account - it will be the key factor determining whether you succeed. We should all be doing everything we can to lift our credit score. One very under appreciated way to do this is through alternative credit data.
Alternative credit data remains a bit of an unknown, though. And there are many misconceptions about it. So: What is alternative credit data? How can we unlock it, and how can it help us?
The problem of
invisible credit
Until just a few years ago, lenders only paid attention to “traditional” credit data. This data formed the basis for how they assessed a person’s creditworthiness, and decided whether to lend that person money.
The problem? The old credit-scoring model missed a lot of people. A May 2015 report issued by the Consumer Financial Protection Bureau stated that as of 2010, about 26 million Americans (that’s about 11% of the adult population then) were considered “credit invisible”. This meant they were consumers without nationwide credit reporting agency (NCRA) records. Meanwhile, an additional 19 million consumers (8.3%) had credit records that were treated as “unscorable” by the scoring models in use back then.
Trillions of dollars of debt were underwritten with the old scoring models. However, FICO, Vantage, Risk Officers and Regulators recognized the need to include other indicators of creditworthiness to help the credit invisible. This gave rise to what is now called alternative credit data.
Alternative versus traditional data
So, what is alternative credit data? And how is it different from traditional credit data?
Traditional credit data is the stuff you probably already know about:
- Credit card history.
- Loan and loan repayment history.
- Mortgage history.
- Credit inquiries.
- Public records such as bankruptcy files.
Alternative credit data refers to forms of credit data that aren’t typically included in traditional credit reports – but can be. With permission from the user, a much wider range of data types can help lift credit, such as:
- Rent payments.
- Utility payments.
- Money management markers, such as how long bank accounts have been open, frequency of withdrawals and deposits, and amount of savings.
- Property and asset records, including the value of owned assets.
- Alternative lending payments such as payday loans, installment loans, rent-to-own payments, buy-here-pay-here auto loans, and auto title loans.
- Demand deposit account (DDA) information, including recurring payroll deposits and payments, average balance, etc.
Life with and without alternative credit data
Without alternative credit data
- You’re just starting out in the adult world, so you decide to move out of your house and ask a trusted friend to cosign for you on your new apartment.
- You try to find work, but no matter how hard you try, the companies you want to get into don’t give you a chance because you don’t have credit history. So you settle for a job that’s “not much, but it pays the bills.”
- Through years of grit and determination, you save up some money for downpayment on a used car, and now all you need is a loan to close the deal. But your credit report is virtually non-existent. No credit report, no loan. No loan = no car. You have no choice but to grin and bear it.
- Then, you decide to ask your friend (again) to cosign for you and help you get your own credit card. After much convincing, they agree. From there, you start building your score. But progress is slow because you’re still building from the ground up.
- Eventually, your score gets high enough to let you qualify for a loan, but it took you about five years to get there. What’s worse, you’re given an absurdly high interest rate because your score is still in the low ranges.
With alternative credit data
- You’re just starting out in the adult world, so you decide to move out of your house and ask a trusted friend to cosign for you on your new apartment.
- Then, you decide to align yourself with a certified data furnisher and get your rent and utility payments reported. And just within the first two months of consistent rent payment, your credit score gets a 28-point jump. Realizing this works, you continue to report your payments.
- You’ve managed to save up enough downpayment for a used car, and when you try to apply for a loan, the credit lender sees all your on-time payments reported by the data furnisher. They take that as a sign that you’re responsible enough to pay them on-time, and so, voila! Meet your new, albeit slightly-used, car.
- From your low-income job, you decide to try to get into that great company you’ve been dying to work for. Coincidentally, part of their background checking on applicants is soft-pulling their credit history, and they see your impeccable alternative credit data record. Within days, you’re now sitting in your new office.
- Within just a couple of years, your credit score has entered the “good” range. You’ve paid off your car loan, and are now considering buying a new car, for real this time. You now have your own credit card, but have learned to manage it well and have used it to your advantage. Your consistent, on-time rent and utility payments continue to build your score, even now when you’ve finally qualified for a mortgage and are just days away from getting your very own home.
Alternative credit
data: not a fad
Because it’s a fairly new phenomenon, the data on alternative credit data is still emerging. But the picture is already very promising.
A new research report from the Policy & Economic Research Council (PERC) indicates that the use of alternative data is presenting an opportunity for financial inclusion. A growing number of companies are using non-financial services data such as energy utilities, cellular payment history, and rent to determine credit worthiness and reach clients that typically would be credit invisible.
The FI2020 Roadmap on Credit Reporting focuses on building and improving credit reporting systems worldwide, including the use of alternative data. One of the three recommendations in this Roadmap is to “enable alternative data to be collected and shared to build the financial histories of borrowers with thin files.” There is a growing interest around the world in developing stable credit reporting systems, and alternative credit data is a big part of this.
Finally, our own research shows how impactful this can be. A study we conducted showed that LevelCredit users experience 20-28 points of credit score growth within just two months of reporting their payments to credit bureaus.
Busting Alternative
Credit Data Myths
Myth #1: Alternative credit data is widely used.
Not quite yet. Older scoring models do not factor it in, and not all lenders have access to it. However, newer models like FICO® '08 include Utilities and FICO® '09 includes both rent and utilities. These new scores are starting to be used by lenders and will provide consumers more chances to improve their credit scores.
Myth #2: It isn’t reliable.
There is no valid reason to discount alternative credit data accuracy. It is recognized under the Equal Credit Opportunity Act (ECOA), and the data comes from legitimate businesses. We validate all of our data through multiple verification methods and data sources.
Myth #3: It’s only good for consumer financing.
During the Great Recession, online lenders were the first ones to tap into alternative credit data for small business owners. Why? Because a business owner might have poor personal credit, but a rapidly growing business that is paying the bills. Alternative credit data may help capture that reality. We may see this again during the COVID-19 Crisis.
Myth #4: Social media affects it.
This is definitely not true. Banks are not and will not be using your social media profiles to assess creditworthiness. It’s against the law. If you have been rejected for credit, then you haven’t met a certain score threshold, or didn't have enough positive credit history. It’s as simple as that.
Conclusion
Traditional credit data is the foundation of the financial industry, and it will probably stay that way for some time. However, alternative credit data is here to stay, and will only grow in importance. Alternative credit data has already become a valuable source of information that empowers consumers to achieve their financial goals and helps lenders with their risk assessment and decision-making processes, and will most likely take on a more impactful role in the coming years.