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Guest Blog: Imagining an Alternative to the Credit Score

July 27, 2021 | Liz Upson

By Shmulik Fishman, CEO and Founder at Argyle

A single number can determine whether you can obtain a business loan, rent an apartment, or take out a mortgage. That number? Your credit score.

Lenders and other financial institutions use credit scores to make critical financing decisions. Your three-digit credit score is a statistical amalgamation of several components, including the total amount you owe, the length of your credit history, and your payment history. Taken together, these factors are meant to demonstrate your overall creditworthiness and by extension, the level of risk to the lender.

While traditional credit scores do reflect an individual’s overall financial situation and economic stability, they also come with some serious limitations. And these limitations are only becoming more pronounced. Below, we’ll discuss some of the shortcomings of the current credit score model and consider a modern alternative that financial institutions can use to make faster and more accurate lending decisions.

Limitations of the Credit Score

Credit scores in their current form have been around since the 1950s. In that time, the US economy has undergone fundamental structural changes. As a result, these scores no longer reflect the financial realities of many consumers.

As it stands today, the credit score suffers from the following critical faults:

It’s delayed

Let’s say you pay off a significant portion of a car loan. After you make your payment, the lender reports your new loan balance to the credit bureaus (generally Equifax, TransUnion, and Experian). Depending on the lender, this report could go out every day, every week, or every month. The typical timeline is 30 days.

That means that whenever you (or a financial institution) looks at your credit score, it’s likely out-of-date by a month or so. In today’s world of real-time data updates, this is a significant delay. And because your credit score can make or break major financial decisions, this delay can have serious consequences.

It’s a black box

Lenders rely heavily on credit scores to make lending decisions, and yet the mechanics of how this number is calculated remain mysterious. FICO has published some general information on how its score is determined including the five main factors (payment history, length of credit history, amounts owed, new credit, and credit mix) and their respective weights. However, even FICO admits that each score is unique to the individual and that their algorithms change frequently.

This lack of transparency produces a number over which both lenders and consumers have next-to-no control. To make truly informed decisions, banks and other lenders need complete access to the information that characterizes an individual’s financial situation. Credit scores simply don’t provide that level of clarity.

It’s inequitable

Credit scores are supposed to remove bias from lending decisions by using a single number to “level the playing field.” However, the reality is that the factors used to determine one’s credit score are affected by inherent biases. Take “length of credit history,” for example. A wealthy family might open a credit card on behalf of their child and pay it off every month. That child then starts at an advantage over those from less affluent backgrounds.

Generational wealth gaps, unequal access to resources, and the long-term effects of race-based financial discrimination like redlining all underlie the factors used to calculate a person’s credit score. As a result, these scores reflect and often amplify existing economic inequalities.

It’s outdated

The nature of work is changing. In the US, the gig economy is now valued at around $1 trillion annually. By 2023, over 50% of American workers will have taken on some kind of gig work, such as ridesharing, grocery delivery, temping, or freelancing. The COVID-19 pandemic has accelerated this trend toward independent work, as many employees lost their jobs and turned to gig jobs for extra income.

Unfortunately, the traditional credit score fails to reflect this new reality. It’s too static for today’s fluid economy, where income comes from multiple employers and can change from week to week or even day-to-day.

What’s the Alternative?

The credit score, which has been around for 70 years, is becoming increasingly dated. But lenders still need a way to evaluate risk. Enter “ability to pay.” This type of calculation is based on current income and employment rather than historical data reported to credit bureaus. Determined by cash flows instead of amount owed and credit history length, it provides a more transparent and accurate view of an individual’s financial situation.

However, ability to pay only works if a lender can build a complete and up-to-date picture of a person’s income and employment. This is where Argyle comes in. Our platform is the first to provide user permissioned, continuous access to a user’s profile, employment, and income history. All of that data is real-time, automated, and fully compliant, and covers the majority of the American workforce, including 95% of the gig economy.

Argyle in Action

As a form of alternative data, we believe that ability to pay, which can be determined via comprehensive, real-time access to employment data, can fill this gap. Argyle also offers companies ongoing access to a user’s information with their consent, saving time and money in lieu of reverifications. Even more, Argyle Calculator takes raw employment data that Argyle retrieves and outputs work and income calculations that lenders, underwriters, auto financers, banks, and more can use to make sound decisions. It makes it possible for financial institutions to get a full and accurate understanding of their users’ employment and income, all in a matter of seconds.

In turn, their decision making is rendered faster, easier, and better informed.

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