The Case for

Unless they are in trouble, most people don’t wake up in the morning thinking about credit. Not even me, and I’ve spent much of my career immersed in it. But for most people, credit is an afterthought, and that’s unfortunate given the impact it has on our lives. Credit is now at a crossroads. It’s evolving right in front of us and that could mean real changes in the way we interact with it. Alternative credit is something we’ll all need to think about, though perhaps not first thing in the morning.

Before I joined eCredable, I spent the prior 7 years at the credit reporting agency Equifax. I got up close and personal with the credit ecosystem, both from the perspective of the creditor as well as the consumer. In my capacity as President of Equifax Personal Information Solutions, I worked with a team of people to create a variety of products targeted at helping consumers understand and navigate the complexities of the credit system. It’s a topic that requires the development of thoughtful and deliberate products that meet the needs of the infrequent credit shopper.

When you read the extraordinary amount of information that is written daily on the topic of credit, from the perspective of the creditor and the consumer, there’s a never-ending discussion on the relevance of credit to our everyday lives. Is alternative credit relevant to the way we conduct our daily financial lives? Now, more than ever, the answer is a resounding “Yes,” and here’s why.

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Traditional credit originates with the national credit bureaus (Experian, Equifax and Transunion) and consists of the payment information you make for repaying debt, like credit card balances, car loans, and mortgages. It also includes negative information like collections, liens, and bankruptcies. It has been around for quite some time. Like any new source of information, it took awhile for credit reporting and credit scoring to gain acceptance across the entire financial landscape. Understanding that the pace of change is highly correlated to the pace of technological advancements, it’s no surprise that automating the decisions associated with credit has been one step behind on this journey. Even though businesses have been able to use credit information in every facet of their decision making processes about consumers (their customers), they never seem to have enough information to further refine their ability to make financial risk based decisions. As the Great Recession exposed the risky lending practices of many lenders, part of the backlash includes a new focus on finding new sources of information to make more informed decisions.

Credit bureaus refer to information that is not contained in a consumer credit file as “alternative data.” In the context of consumer credit, it just makes sense to refer to this same information as “alternative credit” when you consider that this alternative data will be used for credit-related decisions. But why is this data “alternative” in the first place? Why can’t the credit bureaus get all this information housed in the same databases as the information used for “traditional credit?” It comes down to two simple but important business reasons: information availability and compliance with the Fair Credit Reporting Act (FCRA).

By information availability, I mean the ability and desire for businesses that have payment information about consumers to report this information to the national credit bureaus. If there’s nothing in it for them, why go through the time and expense to share this information? It takes people and technical resources to report information to the credit bureaus. The information has to meet a significant number of minimum requirements for the credit bureaus to accept the information (the keys are quantity and quality). In short, you can’t just throw numbers out there and hope they stick.

By FCRA compliance, I mean the legal obligations that the Fair Credit Reporting Act (as well as FACTA, the Fair and Accurate Credit Transaction Act of 2003) places upon data furnishers. (Data furnisher is the name credit bureaus give to companies that provide data to them.) If a business reports information to the credit bureaus, the business needs to be prepared to respond to consumer disputes. In other words, when a consumer applies for credit and he or she is turned down due to an incorrect piece of information that was provided by the data furnisher, the business needs to be prepared to manage a consumer dispute and the potential for a subsequent legal action against the business.

All this adds up to people, time, and money. If businesses can’t significantly offset the expense of providing data with insights that will help them run their business better and be more profitable, then there’s no reason to report data to the credit bureaus. But this doesn’t lessen the need for companies to understand alternative credit. Most businesses want more customers, but they only want more “profitable” customers. They don’t want to extend credit to someone they don’t think can pay them back as agreed. It’s just common sense.

Approximately 75 percent of the adult population in the U.S. has traditional credit. The remaining 25 percent of the population has to get by with alternative credit. Alternative credit is defined as “credit reports and credit scores developed from data sources not typically contained in the national credit bureaus such as rent, utilities, insurance, and other forms of payment.”

If you’re a business, your first question is “how reliable is this information in making risk decisions?” FICO answered this question in 2007 when it released the FICO Expansion Score™, which uses alternative data to produce a credit score. The company was able to demonstrate that the FICO Expansion Score is comparable in its predictive values as traditional credit scores when evaluating credit. The predictability of the score was extremely similar to the FICO Score all the way through the score range of 300-850, until the score reached 780 (in the higher end of the scale, and not very relevant to assessing people without traditional FICO scores). This is important information, since FICO sets the standard for credit scoring.

If you’re a consumer without a traditional credit history (often called “thin file” or “no file” in our world), you’re probably wondering how you can use alternative credit to your advantage. The easy answer is that alternative credit allows you to build a credit history based on things you buy, not things you charge, like utility bills, rent payments, cell phone bills and auto insurance premiums.

The law’s on your side: the Equal Credit Opportunity Act (ECOA) already provides you with the ability to provide this kind of information any time you apply for credit, and the credit grantor must consider this kind of information when using credit related information to make a decision.

Most consumers don’t know about this law, and most creditors don’t want to enlighten them. Why? Creditors have no easy way of accepting and using this information in making risk related business decisions. Creditors are completely hooked on using automated credit reports and scores to make these decisions without human intervention. If a consumer shows up at their place of business with a shoebox full of cancelled rent checks, utility bills marked paid, and various other pieces of paper that proves they paid their bills on time, the creditor would have a lot of work to do to understand the value and validity of this information. (It’s a little like how creditors made risk decisions 50 years ago.)

So what’s a consumer to do? The goal of alternative credit bureaus (like eCredable and others) is to help consumers overcome this challenge. If a consumer wants to avoid going into debt to prove their creditworthiness, but still wants to demonstrate their creditworthiness, having the bills they pay routinely that are not reported to the national credit bureaus can be extremely helpful. For years, creditors have used Alternative Credit in mortgage underwriting. This same approach is being extended to auto loans and credit cards as well.

eCredable is one of the companies helping to address the market need, albeit from the consumer perspective. Experian has expanded its credit file to include rental payment information from some of the larger property management systems that are willing to share data. Equifax has long been in the employment and income verification business, and is looking to complement this information with alternative data. Every year, more companies recognize the need to verify credit worthiness with alternative data, and I believe their requirements for alternative data for risk mitigation purposes will grow exponentially over the next two decades.

Is it time for “Alternative Credit” to join the mainstream credit conversation? It’s long overdue.

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Image: CarbonNYC, via Flickr