There have been recent efforts by the major three credit reporting agencies, Equifax, Experian, and TransUnion (“CRAs”) to secure access to “alternative” credit data in addition to traditional credit data. Traditional credit data includes information from your auto loans, mortgage, credit inquiries, and student loans; and these sources are what have long been used to form your credit score. Alternative data would include information on your rental payments, payments for utilities, asset ownership, alternative financial services data, and consumer-commissioned data; all of which have not been previously used when generating your credit score.
Increased Opportunities for Credit
This push by the CRAs to have access to alternative data is motivated by what they claim would be the ability to extend credit opportunities to those that have previously been unable to gain access credit. Richard Cordray (recent head of the Consumer Finance Protection Bureau) suggests that using “alternative data from unconventional sources may help consumers who are stuck outside the system build a credit history to access mainstream credit sources,” thus giving more visibility to those with so-called “thin” credit files that can be prohibitive when it comes to making large purchases. Essentially, the more data the CRAs utilize, the more financial information lenders can use, and the easier it will be to build credit.
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Recent data from NYC appears to support this prediction. A study completed by the NYC comptroller in 2017 found that including alternative data when generating credit scores led to a 28.7% increase in credit scores, with the average score reaching 700.
However, there are some who are concerned over this development, claiming that the ability to use alternative data could further disadvantage those already struggling. One critique emphasizes the fact that many who are unable to attain loans through the use of “traditional” credit data turn to short term lenders who exploit consumers by offering loans that can’t be paid off in the amount of time allotted, and apply high-interest rates.
The “payday loan” practice currently loans out $90b a year and is expanding into online spaces. Many online lending companies are using alternative data gathered from credit bureaus or directly from consumers, as well as information accessed from other short term loans that have not been tracked by credit agencies. This shift also sees the CRAs acquiring data tracking collection agencies to collect alternative data that can give lenders “more confidence in their decision and allowing consumers to gain access to lower-cost financing.”
As this practice expands, it could create new opportunities for legitimate lenders to exploit borrowers through harsher penalties and end up hurting their credit in the long run. Chi Chi Wu from the National Consumer Law Center suggests that creditors are interested in this data not only to extend credit opportunities, but to also use that information to make sure consumers keep up on their bills.
Accuracy and Protection
Another concern about the use of alternative data is that it may inaccurately reflect someone’s financial situation. Without additional information, data may be misinterpreted and ultimately lead to a lower credit score. Many consumers are forced to strategize their bill payments from month to month, prioritizing one bill over another for various reasons, and letting other bills go unpaid for a time. Should the reporting of this information become more routine (currently it’s only reported if one falls really behind in payments or is sued by a landlord), it could have substantial impacts on how families are forced to pay their bills.
Importantly, some states have laws that protect consumers from having utilities shut off in high-cost months (e.g. winter or summer months), allowing them to not pay in full until a later date. The use of this form of alternative data may affect how those laws work in conjunction with data reporting.
Lastly, the access and transfer of more data ultimately increase the threat of identity theft because it provides more access points for would-be thieves. It also increases the probability of credit report errors which can be costly to rectify. One report suggested that because some alternative data is not protected under the Fair Credit Reporting Act, credit report errors that result from the misuse of that data would not be protected; removing an important path for consumer protection.
We’ll stay informed on this discussion as it develops. Having a thorough understanding of the data used to generate credit is imperative for understanding the vulnerabilities that could come with it, and how effectively respond to problems that that may arise.