Credit scoring alternatives for people without credit

When you apply for a loan, the lender examines your credit score to determine your loan eligibility and the interest rate. Your credit score is calculated from things like your credit card and mortgage payment history, and the status of other active loans you may have. But about 45 million Americans don’t have a credit score simply because those data points don’t exist for them, which limits their ability to get a loan to buy a home or a car.

Today’s WatchBlog article examines our recent reports on how lenders are increasingly exploring alternative information or data that is not typically used in credit assessment to determine loan eligibility, and what consumers should know about that data.

Why someone might not have a credit score

Not having a credit score doesn’t necessarily mean someone is in financial trouble or poses a risk to lenders. Usually, when people don’t have a credit score, it’s because they don’t have a credit history or recent credit usage. It could just mean that they are using cash or debit cards instead of credit cards, or that they haven’t taken out any loans. Lack of credit rating can also occur if all of a household’s credit cards or loans are in the name of a spouse or partner.

In our November report, we found that people with no credit score tended to be low-income, younger, and belonging to minorities.

Credit rating: traditional data versus alternative data

Credit bureaus are national entities that collect data from financial institutions about the people who use their services, such as credit cards or banking services. This information is then used to determine their creditworthiness (or score).

As described above, these reports include items such as mortgages and credit cards, as well as data that shows negative credit performance such as foreclosures and bankruptcies. The credit bureaus then analyze this data to create credit scores for consumers. These reports and scores help determine your loan eligibility and the interest rate you will receive on that loan.

But more and more lenders are turning to alternative data to determine loan eligibility. Alternative data is information not used in traditional credit reports and can be financial or non-financial in nature. It can include information such as your banking transactions; your on-time rental, utility, or telecommunications payment data (traditional credit reports typically only include late payments); and the educational institution you attended and the degree you obtained.

In our new report, we found that while lenders can use alternative data to take out larger loans (like mortgage loans), this has been rare. Instead, lenders more frequently use alternative data for small consumer loans, such as issuing credit cards or car loans.

In fiscal years 2016-2020, only about 0.31% of FHA-insured loans (designed for low- and moderate-income borrowers with low credit scores) went to borrowers without a credit rating, which means they probably used alternative data for the subscription. .

The pros and cons of alternative data credit scoring

Alternative data can help some consumers build a credit score or improve their existing score by adding information to their credit reports. This in turn could improve their chances of getting a loan and reduce the amount of interest they pay on the loan.

However, the use of alternative data could also present risks for consumers. This data could lead to discrimination or a violation of fair lending laws and could create data privacy risks. For example, lenders could use alternative data such as education level to determine a person’s loan eligibility, but this in turn could cause the lender to discriminate against populations who have traditionally had lower rates. obtaining lower university degrees.

There are also concerns that the collection of alternative data could violate consumer privacy if lenders or credit bureaus collect alternative data without consumers’ knowledge or permission.

Get alternative data counted in your credit score

There are steps you can take to ensure that this data is included in your credit score. If you want alternative data to be used in your credit scores, you should generally opt for credit products available from private companies that collect this data in a credit score. Existing products are usually offered by credit bureaus.

Want to learn more about our recent work on alternative credit data? Consult our reports for November 2021 and March 2019.

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