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Banks want to make loans to people with scant credit histories, but the challenge is figuring out how to do so safely. One possible solution is to look at alternative data. Eager to book more loan business, more and more banks are considering such factors as rent payments, purchasing patterns, even an applicant's spelling to help predict creditworthiness.
February 24 -
Think Finance CEO Ken Rees says social networking data can provide clues that help with underwriting.
January 16 -
FICO discards incomplete and old credit history information for a good reason. The solution to today's credit-access problems is not to use this unreliable data but to turn to alternative data such as the payment of everyday bills.
June 2
The financial services industry is engaged in a rousing discussion about credit scoring with alternative data. But if you ask me, debating credit-scoring techniques is a bit like arguing over the arrangement of turnstiles at Disney World. The debate might end up making the entry line a little faster and more efficient, but anyone who cant afford the $100 cost of entry is stuck outside. And when it comes to the U.S. credit system, far too many people today are in that position.
Nearly half of the U.S. population today faces
Regardless of how good we get at crunching the numbers on every borrower, the fact still remains that every single person participating in our economy will face rocky terrain of limited and volatile earning power at some point in his or her life, and likely more than once.
This is a big deal. A single mistake can deny a good borrower access to credit and, at a minimum, diminish their ability to secure a fair rate. For example, many Americans with excellent credit scores can lose up to 100 points off their credit score for a single 30-day late payment. Even worse, getting that credit score back on track can take upwards of two or three years.
Contract workers and hourly employees are particularly likely to see their income change dramatically each month. Rent and living expenses, however, are generally constant from month to month and usually go up over time.
Regardless of their credit scores, people in these situations are bound to run into months where expenses outpace income. In fact,
This is a sobering economic reality and it doesn't get fixed just by assigning credit scores to more individuals. Sure, that can help on the margins, but the credit industry shouldn't claim victory simply because it's now possible to assess more people for credit eligibility. Unfortunately, updated credit assessments will be poor more often than not and the resulting cost of credit for these borrowers will be too high.
Rather than focusing on credit scores, we should ask ourselves how we can change the game so it's not rigged against the people who make up the foundation of our economic system. How can we ensure that the people who need credit most arent priced out by fees and interest?
Credit is more than just a risk calculation. Its a social-psychological behavioral phenomenon. The issue is that the credit-scoring system presumes that certain people are creditworthy while others are not. But creditworthiness is not a quality that a person can "have." Everyone and anyone can "behave in a creditworthy way" in the right situation, if they have the right people in their lives and the right support and encouragement. Credit scores don't tell the whole story.
Conversely, just because someone has a high credit score doesnt mean that they can handle every kind of debt. In a bad situation, someone with a high credit score can still behave in an un-creditworthy way.
Every trained social psychologist will assert that human behavior is the result of personal factors combined with situational factors. To date, our modern credit system has been rigged to measure only personal factors: income, debt load, housing expenses, personal financial history, and so on. As an industry, we have not systematically started to measure situational factors to factor in how culture, norms, incentives, and constraints that surround every single person in our economy.
Life is short and our economic problems are big. Let's not spend too much time and energy on marginal improvements. Financial companies and banks must begin considering new ways to understand and serve our customers.
Yee Lee is chief executive and co-founder of Vouch Financial.