Alternative credit-evaluation methods and what they mean for you

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In a Nutshell

New ways to evaluate borrowers’ creditworthiness are emerging thanks to innovation in data collection and analysis. From direct access to your bank account to scanning mobile phone text logs, creditors are considering data from new kinds of sources when making lending decisions.
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One day, your cellphone usage could directly impact whether you can get a loan. It’s not happening yet — at least not in the United States. But internationally, companies are using various types of data to assess creditworthiness.

In the U.S., most FICO® and VantageScore® consumer credit scores depend entirely on the information in your consumer credit reports. Within this context, alternative data often refers to information that isn’t commonly reported to the big three credit bureaus — Equifax, Experian or TransUnion — such as your rent, cable TV, internet or other monthly payments.

Some companies are starting to go further, though. They’re using a variety of other data — data that’s not from the credit bureaus or your payment activity — to evaluate consumers’ creditworthiness around the world.



Lenders using new kinds of data to evaluate borrowers

Branch is one example of a company using alternative data to make lending decisions. The company offers small loans in Kenya, Tanzania, Nigeria and Mexico, without relying on applicants’ credit reports or scores — in fact, many of these applicants have neither.

Nick Handel, the head of data science at Branch, says the company looks at interactions the applicant has had with Branch, such as how they repay loans, which loans they select and how they’ve interacted with customer service. “Then, there is user-provided data that they provide from their device,” he says. “That’s stuff like the contact lists, GPS information, SMS logs, call logs.”

In these markets, many financial transactions happen through text messaging rather than email, so access to SMS logs could give information about the person’s cash flow, Handel says.

Branch also gets insight from nonfinancial information. For example, the completeness of someone’s contact list (e.g., a full name, number and address) and whether the person capitalizes their contacts’ names could be factors in making a lending decision.

If an applicant’s phone is well organized, they might be more business-minded — and therefore a better credit risk, says Handel.

Branch uses machine-learning and -modeling techniques to improve its scoring models over time. Starting in markets where a $2 loan could offer the borrower significant buying power can help, as the company can afford to make many low-value loans and collect information about borrowers. Still, it’s a learning process.

“We’re in very early days of understanding it and extracting the right information,” says Handel.

Regulation could make it difficult to adopt new lending metrics in the U.S.

One reason you may not see your text messages or contact list being used by creditors in the U.S. is that federal laws regulate how information can be used in lending decisions.

The Equal Credit Opportunity Act prohibits discriminating against credit applicants in several protected classes, including race or color, religion, national origin, sex and marital status. To comply with the ECOA, lenders can’t treat applicants differently based on whether they belong to one of the protected classes.

Additionally, lenders must be able to prove that their underwriting process doesn’t have a “disparate impact” on a protected class. In other words, even if a lender doesn’t consider applicants’ religions, it still may have to show that its approval process doesn’t have a disproportionate impact on members of any particular religion.

Determining which variables are predictive and being able to show they don’t accidentally discriminate against a protected class can be a difficult and costly task for lenders. This may be one reason we don’t see the use of eye-catching metrics, like social media usage or your phone’s contact list, being integrated into lending decisions the U.S.

While adding new metrics into the mix can be risky, companies are taking steps to determine creditworthiness in different ways and increase financial inclusion in the U.S.

Expanding financial inclusion in the U.S. through access to credit

Using non-bureau data to assess creditworthiness

“We’ve taken the regulatory framework and limitations into account,” says Kalpesh Kapadia, the CEO and founder of Deserve, which offers a credit card to customers based on alternative data points.

Applicants don’t need a credit history and may not need a Social Security number to qualify for a credit card from Deserve. Kapadia says applicants can share read-only access to their bank account data, which can then be used to help verify their identity and predict their ability to repay loans. Deserve can use this access to see if applicants have nonwage income, such as transfers from a parent, and if they make regular bill payments that aren’t reported to the credit bureaus.

“Regular payments and regular income — we give you credit for that,” says Kapadia.

Deserve also uses social media to help verify an applicant’s identity. And if you’re approved, connecting your social media accounts could lead to a higher credit line.

Considering international credit history

Nova Credit, founded in 2015, is another company that’s worked to expand access to credit for immigrants, international students, or employees and expats who are returning to the U.S.

The company collects data from international credit bureaus to create a “Credit Passport™” for consumers. Giving creditors and landlords access to this data may help applicants qualify for more financial products, higher credit lines and rental units based on their non-U.S. credit history.

Integrating some types of alternative data into credit scores

FICO is considering ways to use non-credit-bureau data in to evaluate borrowers. For example, the FICO® Score XD and FICO Score XD 2 models incorporate telecom and utility data from sources such as The National Consumer Telecom and Utilities Exchange® Inc.

Some newer FICO® and VantageScore® generic credit-scoring models also take your rent payments into account — but your landlord or property manager needs to report the payments to the national credit bureaus first.


Bottom line

Today, it’s fairly easy to get free access to one of your FICO® or VantageScore® credit scores. What might not be as visible to you is the alternative credit metrics that some companies are starting to consider as part of their underwriting processes.

That said, you don’t need to know how the sauce is made to benefit. If you’re having trouble getting access to credit due to a lack of credit history, or past credit problems, working with creditors that use alternative metrics might help.


About the author: Louis DeNicola is a personal finance writer and has written for American Express, Discover and Nova Credit. In addition to being a contributing writer at Credit Karma, you can find his w… Read more.