Many Americans often can’t get loans to buy homes or start businesses because they lack sufficient credit history to generate a credit score. This is particularly true for many minority or low-income consumers.
To address this issue, the Consumer Financial Protection Bureau is seeking public feedback on the benefits and risks of using alternative credit data from non-traditional sources such mobile phone bills and rent payments to make lending decisions for consumers whose lack of credit history prevent them from securing loans. The bureau is accepting public comments on this request for information through May 19.
Currently, lenders use standard credit history information such as payments on credit cards, loans and mortgages along with a credit score from consumer reporting agencies in determining the credit worthiness of a borrower.
“Alternative credit from unconventional sources may help consumers who are struck outside the system build a credit history to access mainstream credit sources,” CFPB Director Richard Cordray said in a Feb. 16 news release.
Credit invisible
The CFPB estimates about 26 million Americans are credit invisible, meaning they have no credit history with a nationwide consumer reporting agency. Another 19 million consumers have a credit history that has gone stale, or is insufficient to produce a credit score under most scoring models, according to the CFPB release.
Banking industry officials have expressed mixed reaction to the CFPB’s plan. Joe Gormley, assistant vice president and regulatory counsel for the Independent Community Bankers of America, said “community banks have been making credit decisions for their customers for a long time, well before the development of credit scores.”
“We have been comfortable for many years in looking at many other factors about a customer outside of a traditional credit score when deciding to make a loan,” he said. “We like to take a holistic view of each customer when making lending decisions and have done so for a long time.”
However, Gormley said many community banks are concerned regarding the possible implementation of a plan by the CFPB to require other credit metrics be used when making credit decisions for consumers that are credit invisible, and the lack of prescriptive rules for the process of underwriting a loan.
Regulatory burden
“Adding an additional burden on community banks to comply with new requirements diverts many of their resources that could be better used to serve their customers and local communities,” he said. “With every new requirement added, it also adds new compliance measures that take up additional time for employees, a variety of resources and money, that could all be better spent serving customers.”
Josh Silver, senior advisor with the National Community Reinvestment Coalition in Washington, D.C., said “using alternative credit data could be helpful for consumers; however, it could also be harmful if not used correctly.” He cited one example of possible harm as when some lenders look at what college a consumer attended.
“Some fintech lenders have been making the presumption that if a potential borrower graduated from an Ivy League school, the expectation was that these consumers would have a higher annual income in the future, and that is not always the case,” he said.
Silver said federal banking agencies published a question-and-answer document and issued it to banks on July 25, 2016 regarding the use of alternative data when making lending decisions for middle- and lower-income consumers. The purpose was to guide lenders in making responsible loan decisions for borrowers that are traditionally underserved, while also maintaining safe lending practices with products that don’t have abusive terms such as high interest rates, he said.
Accurate data
Cy Richardson, senior vice president for economics and housing at the National Urban League in New York, sees potential benefits in the use of alternative data for consumers who lack credit histories, but noted the data must be used properly.
“For people who don’t a credit file or have a thin file, the use of alternative data could prove very helpful,” he said. “On the other hand, the reality is that many times systems are being used that were put in place 30 to 40 years ago, and these don’t always reflect the current realities in today’s world and practices.”
Richardson said it is vital any alternative data used when making lending decisions is to up-to-date and verified.
“The credit reporting agencies are capturing and reporting credit data, but how accurate is the data they’re collecting? Is it reflecting a person’s situation in real-time? There is no enforcement mechanism in place to assure quality control on credit reporting agencies regarding the accuracy of the credit data they have on consumers,” he said.
The National Urban League along with the CFPB were early adopters of the model of looking at alternative credit data for consumers such as rent payment history, according to Richardson. However, landlords are the middle men and the data will only work and prove helpful to consumers who are otherwise credit invisible, if landlords report reliable and timely payment history of their tenants to credit agencies.
“Consumers need credit and many times the lower and middle income folks are left out and are off the traditional financial grid,” he said. “Given that we’re in a risk-based lending environment, we need to work towards having their alternative credit data captured to bring them on-board so their credit history counts.”
Freelance writer Carole Jakucs contributed to the writing and research of this article.
To read related article on the proposed use of alternative data in credit scoring, click here.
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