Author: Michael Shurley
Once upon a time (in America), there were three big credit bureaus, all gathering the standard information that creditors needed to make sound lending decisions. But now, they’ve been joined by a “fourth bureau” – in reality a collection of companies that mine alternative forms of data to tell their story about prospective debtors. So, should consumers and businesses be spooked – or is this a tale with a happy ending for all?
Let’s start at the beginning…
In the US, and also the UK, the three main credit bureaus are Experian, Equifax and TransUnion. These powerful institutions all work in much the same way, putting the data they collect on each debtor into a credit report and calculating a score based on this information.
The data traditionally collected by the big three bureaus include “tradeline” information on existing loans, credit limits, debt repayments and account status; credit inquiries; and information from public records relating to bankruptcies. Core credit files can also incorporate data from previous credit applications, such as income or length of time in employment.
Mostly, credit scores based on traditional data tell a true enough story about debtors and their likelihood of repaying a loan. But sometimes, the information may be woefully insufficient – making the credit file in question something of a slim volume. And that’s where the fourth bureau’s alternative credit data can prove useful.
Are you only getting half the story?
In simple terms, credit decisioning models that use alternative sources of data give lenders more information to work with – which may be good news for certain groups of consumers.
Being a “bad borrower” and frequent defaulter is only one reason for scoring poorly with a bureau. You might also have never used credit before or not have needed it for many years, resulting in a “thin” credit file with little data for lenders to go on.
Young students, recent immigrants and older people that have long paid off their debts could all, for example, have thin or non-existent credit files with the major bureaus – and either low or no credit scores. And as a result, they could well be turned down for a loan that they might easily or reliably repay.
Here, both the prospective borrower and the potential lender lose out on a loan opportunity. With a greater range of alternative data sources to interrogate, lenders could get the evidence they need to identify and underwrite more “good borrowers”. The proof may be out there, beyond the core credit file; and the fourth bureau is increasingly adept at tracking it down.
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Further reading – what counts as alternative credit data?
Alternative credit data is basically any information that’s not usually part of a traditional credit report. According to Experian, “This data provides more insight into both full-file and thin-file consumers, to drive greater visibility and transparency around inquiry and payment behaviors. Adding the information from alternative credit data sources may allow some consumers to gain more access to credit.”
Sources of alternative credit data include:
- Bank accounts
FICO, the US provider of credit scores, is now bearing in mind how much cash consumers have got in their bank accounts, along with other indicators of how well they manage their finances. With consumers’ permission, FICO will use factors such as how often they make withdrawals and deposits, how long accounts have been open, and levels of savings, to calculate its UltraFICO score.
- Social media profiles
Controversy alert! While online commentary about a business (e.g. consumer reviews about a product or service) could reasonably be included in a commercial credit assessment, lenders can’t currently use social media channels to make credit decisions on consumers. Ultimately, credit data must be “displayable and disputable”, and social media profiles – unlike payment histories – can be easily manipulated or judged on attributes that may not relate fairly to creditworthiness. Social media data may well play a role in consumer credit decisioning in the future, but lenders and regulators are still working out how well it can predict credit behavior, while respecting privacy.
- Everyday bills and payments
Consumers’ ability to keep up with payments for rent, electricity, mobile phones, cable TV and so on can provide important clues to their financial conduct and general creditworthiness. But to date, rental and bill payment data hasn’t typically found its way into traditional credit reports. For the fourth bureau, however, it counts as a key feature of credit histories.
- Alternative lending payments
As another stranger to the credit report, data on payday loans, “buy here pay here” finance agreements, auto title loans and the like can provide additional intelligence on consumers that relates directly to their probability of default.
- Application forms and calls
It may sound obvious, but the credit application form itself can yield useful information that, again, doesn’t often make it into traditional credit reports. The same goes for phone calls made to customer service teams, which of course will usually be recorded “for quality and training purposes”. Whatever’s been written or said could well help bulk up a thin credit file.
- Property and asset records
A record of property and assets, including the value of owned assets, could easily shed more light on a consumer’s financial viability.
- Psychometric tests
Through scientifically crafted surveys and questionnaires, lenders or credit scorers can gain new insight into the psyche of potential debtors and compensate for credit histories that are short on traditional data.
- Online behavior
Website owners, including lenders, can see exactly how a consumer clicks through their pages and how long they spend on certain sections. All this “clickstream” data may shed useful light on the borrower’s potential behavior as a debtor.
Twists in the tale
While tapping unconventional sources of data can clearly benefit consumers by improving access to credit, there is another side to the story – and a potentially scary one at that.
On the one hand, the fourth bureau can fill in the gaps of a sketchy credit history. But on the other, it could be telling tales that consumers might rather leave untold. And if you’ve spent your life meeting the requirements of traditional credit reporting, how frustrating for a missed utility payment to suddenly undermine your score?
However, research shows that consumers are actually open to sharing more credit data. Seventy percent are willing to provide additional financial information to a lender if it increases their chance of approval, and more than half believe it would have a positive impact on their score. Forty-eight percent would prefer their utility bills to be evaluated in their credit history, 39 percent their savings account transactions and 38 percent their mobile phone bills.
A new chapter for credit scoring
As the story of the fourth bureau unfolds, it’s looking less like science fiction and more like an acceptable part of everyday credit scoring. Somewhat ironically, all of the big three credit bureaus increasingly include alternative data in their credit files, even if it doesn't yet make it directly into their reports and scoring models.
For some consumers, the growing intrusion of the fourth bureau into their payment habits and even digital lives may feel unwelcome or even creepy. But overall, the additional information could help lenders extend credit to more individuals – by delivering a more comprehensive, rounded view of the consumer.
And in the end, isn’t it always best to get the whole story?