The latest in an ongoing discussion about the crossroads of alternative and traditional credit data.

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It is well known that in order to get “traditional” credit (a credit card, loan, lease, etc.) from a “traditional” lender (i.e. the bank) you need to have a credit score. If you don’t have one (and 53 million Americans do not), then you are invisible to the traditional credit bureaus and therefore unscorable.

The logic follows that if you are unscorable then you cannot qualify for a traditional loan, credit card, etc. That is not good news for these 53 million people – many of whom deserve an opportunity to participate in mainstream credit. So how can that happen?  Let’s expand by answering two more questions:

Who are these 53 Million “Unscorables”?

Let’s start by dividing unscorables into four groups:

  1. New To Credit (NTC) – Consumers with no sufficiently established tradeline history with the 3 major national credit reporting bureaus. They may appear on the bureau as a “header” record only meaning they have applied for credit but has no record of any payment history. This group is primarily made up of younger people just starting out and are caught in a slight variation of the chicken/egg conundrum – that is, “you need credit to get credit”.
  2. Credit Bureau No-Hit – Consumers having no presence on the three major national credit reporting bureaus at all. These consumers have never applied for traditional credit and are represented disproportionately by low-income minorities (primarily African American and Hispanic).
  3. Voluntary Inactive – Consumers with robust, clean bureau reports but lack recently reported activity. Think of elderly folks who are no longer buying homes and new cars.
  4. Derogatory – Consumers with negative history and only recent activity of derogatory collection accounts. On the bureau reports but have run into situations that caused them to fall behind. Typically, those who have had major medical bills, job loss, a catastrophic event or, unfortunately a combination of all 3.

We will skip over group #3 today because, by definition, they are intentionally not actively seeking credit. We touched on the 4th group in my last post. So let’s spend some time on the plight of the 1st and 2nd groups – the new to credit and the credit bureau no-hit (a.k.a. the Credit Invisibles) consumers.

Why Do They Matter?

A recent report published by the CFPB found that African-American consumers, Hispanic consumers, and consumers in low-income neighborhoods are more likely to be “credit invisible.”1 The Credit Invisibles have to rely on alternative credit services like payday loans, check cashing services, pawn shops, etc. Most of the lenders [under-]serving this segment do not report to the credit bureaus.  These lenders charge very high APR’s – some exceeding well over 300%. The people in this segment are, for lack of a better word, trapped in a vicious cycle from which it is extremely hard to break. A study done by Pew Trusts Research identified five groups that have higher odds of having used a payday loan2:

  1. Without a four-year college degree
  2. Home renters
  3. African Americans
  4. Earning below $40,000 annually
  5. Separated or divorced

An analysis published in the “Alternative Data and Fair Lending” White Paper by LexisNexis® Risk Solutions shows a significant percentage of this underserved community would perform similarly to prime and near prime consumers as determined by their robust credit bureau footprints.3

Is it because of regulatory concerns or the near-sightedness of the mainstream credit industry that very little effort has been made to include this segment in traditional lending products?

And because of this chronic myopia, mainstream lenders do not and cannot truly advance the social benefits associated with expanding credit to consumers that are financially excluded, especially underserved minority consumers.

With respect to the traditionally underserved minority consumers, 41% of those consumers are unscorable. By leveraging alternative credit scores, 81% of those consumers can be scored to assess creditworthiness.  Roughly 27% of those consumers were found to have default rates similar to prime consumers, through the use of alternative credit scores.3

The bottom line for lenders is this: they are missing an opportunity to acquire profitable new customers. In the aforementioned LexisNexis Risk Solutions study, 24% of U.S. consumers are unscorable using traditional credit scores. Roughly 51% of those consumers were found to have default rates similar to prime consumers through the use of alternative credit scores.3   We are talking about net-new customers to the market. This is not just about a lender taking customers from a competitor, this is about expanding the market by bringing affordable credit to segments of the population who have never had the opportunity to participate in the mainstream credit marketplace.  A win-win-win situation for the borrower, the lender, and society.

1  //files.consumerfinance.gov/f/201505_cfpb_data-point-credit-invisibles.pdf

2//www.pewtrusts.org/~/media/legacy/uploadedfiles/pcs_assets/2012/pewpaydaylendingexecsummarypdf.pdf

3//www.lexisnexis.com/risk/downloads/whitepaper/fair_lending.pdf

  1. Can alternative credit services bail out a person in the vicious cycle? How about acquiring a Consolidated loan at a lesser rate? How about being declared bankrupt?

    • In regards to bankruptcy, there is a school of thought that many people who filed bankruptcy during the last recession are actually good credit risks because they endeavor to build their credit back up.

      This topic is worthy of much more attention and analysis.

      Alternative data provides insight to a person’s Stability, their ability to pay and their willingness to pay. When you can understand these aspects of a consumer more clearly then the ability to predict their “credit worthiness” is greatly enhanced.

  2. Alternative credit services fill a market need. That need is based on the fact these people cannot qualify for traditional credit products. If the alternative credit service reports payment behavior to a Credit Bureau, then yes, they could break out of the cycle. However, many of these services do not/cannot report to the 3 Credit Bureaus. Check out this from the CFPB in respect to Payday loans: //www.consumerfinance.gov/askcfpb/1635/if-i-take-out-payday-loan-could-it-hurt-my-credit.html.

    Consolidation loans at reasonable interest rates are being considered by traditional lenders. The challenge for the lender is to properly, consistently assess the riskiness of the consumer. And it is working. Check out how Kinecta FCU/Nix Neighborhood Lending is solving for this: //news.cuna.org/articles/108192-cu-effect-nix-kinecta-combat-payday-loans-one-borrower-at-a-time

    I also wrote about them in my July Blogpost.

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