In a Nutshell: Credit scoring agencies have used the same data to determine credit scores for years, which renders a lot of important payment information — think rent, mobile phone, and utility payments — useless to most scoring models. Experian, one of the three major credit bureaus in the US, recently released the findings from its State of Alternative Credit Data report and found that 53% of respondents believe some of these alternative data sources — which also include savings and checking account transactions — would positively affect their credit scores. With technology making it easier to collect and securely store personal payment history, alternative data could contribute important factors to future lending decisions.
For many consumers, credit scores consist of a convoluted mish-mosh of data points and vague information that makes it difficult to determine what they’re judged on and how to improve the way they’re seen by lenders.
Terms like inquiries, installment and revolving debt, and delinquencies are commonplace for people in the financial world but can seem like a foreign language to someone outside of the inner circle.
We often hear complaints from readers who are fastidious in paying their rent, utilities, cellphone payments, and other monthly bills, but can’t understand why a few credit card late payments in the past 24 months have sunk their credit scores to new depths. Shouldn’t the positive payment history of the other bills offset some of the damage from previous mistakes?
The obvious answer is yes, but the technical answer is no. While the three credit reporting bureaus, Experian, TransUnion, and Equifax don’t include utility and cellphone data in credit reports, so they are not part of credit score calculations, Experian now includes rental payment history in its standard credit report. Since most of these services use credit report data to determine pricing and eligibility, it seems only fair that regular, on-time payments would also factor into a person’s credit history.
Experian looked at these alternate data points, and how lenders could use them to create a more accurate picture of a consumer’s creditworthiness, in its recent State of Alternative Credit Data report. In the national survey, 53% of consumers said they believe some of these alternative sources — which also include savings and checking account transactions — would positively affect their credit score.
“We’re all familiar with traditional credit — things like credit cards, retail accounts, and installment loans,” said Rod Griffin, Experian’s Director of Public Education. “These are the kinds of agreements with lenders that we’ve used for decades and are ubiquitous with making future lending decisions. Alternative data are things like rental, cellphone, and utility payment data.”
Nearly 80% of the lenders surveyed said they rely on a credit report, plus additional information, when making a lending decision. The data is used to determine a consumer’s level of risk and ability to repay and helps lenders decrease loan defaults.
This data not only helps consumers with low credit scores improve their access to more affordable loans, but it brings people with a lack of credit history — also known as credit invisible — into a clearer light. Many of these individuals pay their bills on time each month but lack the credit history required for loan approval.
“We believe these data points can be very valuable in helping a person become more financially successful,” Griffin said. “They can help people break out of the cycle of high-cost credit and being credit invisible. By using alternative data, our goal is to help people establish credit so they have access to the kinds of credit they need at rates that are fair and come at a lower cost.”
Griffin pointed out that 95% of Americans have cellphones, with a majority of those people making payments every month toward a data and minutes plan. Many other consumers make regular payments for cable television or home internet access. Those payments aren’t currently factored into credit scores.
“Other things that are less credit-like, but still related, are things like bank account information,” he explained. “That’s not part of a credit report right now, either. We’re looking at savings and checking accounts — anywhere you might make a regular deposit and not make an overdraft while using the account responsibly.”
Subprime Lenders are Most Receptive to Data Usage
Griffin said that many surveyed consumers said they’d be willing to offer alternative data to lenders if it benefited them, while other consumers have raised concerns over the privacy of their information. Experian has worked to provide safeguards that ensure the proper usage of any data collected.
“At Experian, we believe that any information used must have benefit to both the business and the consumer,” Griffin said. “We have to be sure that all information used complies with things like the Fair Credit Reporting Act. So, when alternative data is used, it still has to be displayable, disputable, and correctable by the consumer.”
That data, to date, is most valuable to subprime lenders. These businesses provide various financing opportunities to consumers who may not qualify for traditional bank loans — either because of a damaged or invisible credit history.
“Alternative data gives valuable insights across the lending spectrum, from prime to subprime lending,” Griffin said. “Specifically, alternative data offers new ways for lenders to include more people. This helps them validate people who may not show creditworthiness through traditional methods.”
Traditional prime lenders, which can include banks and credit unions, are less open to new methods of data because, according to Griffin, the way they’re currently operating works for them.
“Prime lenders are looking at people with established history and a strong credit score,” he said. “These organizations are probably less willing to use this information at this point and it may take them longer to adapt to using alternative data sources.”
Credit Reports aren’t Just for Lending
People expect their credit score to play a major part in the success or failure of a loan application. This age-old practice won’t be changing anytime soon. But other businesses also use credit scores in the approval process of consumer applications for mobile phone, cable television, and utility services. Some insurance providers also use credit information to determine policy pricing and eligibility.
“If you think about how credit reports are used today, it’s not just about lending,” Griffin said. “Credit reports are used in so many other ways — things that also include apartment or housing rentals. Just about anything that requires a regular financial agreement, even if it’s not in the financial world, might look at some sort of credit data.”
In recent years, collecting alternative data has become easier thanks to the proliferation of technology that collects, stores, and secures data on servers around the globe. The next step for companies like Experian is finding ways to use the data properly, and in a way that is acceptable to consumers.
“People are now more comfortable with giving that data out if it brings them a benefit,” Griffin said. “We found that 60% of people we surveyed thought their credit score accurately reflects their creditworthiness, but 47% said they believe they’re better borrowers than their credit score represents.”
More than half of the people surveyed said they felt alternative data would help their credit scores and would consider sharing the information if they see a value and can control the usage.
Trended Data Helps Form a Credit Score Longview
Griffin said he expects the future of credit scoring to look drastically different than what we’re used to today. The first step toward that change will likely come when the credit bureaus expand the scope of consumer data they use to determine creditworthiness.
“One thing to think about is not only are there new kinds of data being used in decision-making, but there are new ways to use existing information,” Griffin said. “One of the things I’m sure we’ll continue to see is trended data. Credit reports currently represent a snapshot of your payment history at a moment in time. That doesn’t always give the clearest picture of how a person manages their finances.”
Griffin used the example of a seasonal worker who may work in construction or agriculture and have very little income at one point of the year and then have a windfall come all at once later in the year.
“You might see someone in one of these fields have a slip in their payment history over the offseason, but then come back in the work season,” Griffin said. “Looking at credit information as a broad view over a period of time, instead of a snapshot of this moment, could show that these people are a very good credit risk even though they have some late payments at certain times of the year.”
Most consumers want lenders to see them in the proper light when they apply for a loan. While they may have the occasional late payment over an extended period of time, their on-time payments for several other accounts should factor into determining creditworthiness. Currently, that data is not available to credit bureaus. But if current trends in consumer attitudes have any say in the matter, that may soon change.