Over the last few years, a growing amount of attention in the lending industry has been paid to just how many people are shut out of it. While using past credit performance to evaluate a person's future creditworthiness has long been a staple for financial institutions of all kinds, there has been a larger emphasis on reaching people who might not have been included in the system overall.
The fact of the matter is that traditional credit, while good in some respects, often fails to paint a complete picture of how a person handles their money every month. For instance, if a person pays every bill they have – for their cell phone, rent, utilities, student loans, and so on – but misses an auto loan payment, the damage to their credit score is going to be sizable and take months or even longer to repair. Part of the reason for that is simple: Most of a person's monthly bill payments do not in any way factor into their credit history. Making matters worse, the influence a bad credit rating has on access to or the price of credit is enormous. For example, as demonstrated in one New York Times analysis, for a $100,000, 30-year mortgage, a buyer with a FICO score of 760 will pay as much as $70,000 less in interest than a buyer with a credit score of 620.
That's why many financial institutions are starting to wake up to the new possibilities afforded them by alternative credit scores, which have actually been around for about a decade. Put another way, they're starting to see the things that traditional credit scoring models don't do that well:
1) They only punish people when they can't handle other bills
Every month, millions of Americans who have what are known as "slim" credit profiles do a perfectly good job of keeping up with all their bills, but don't have much access to credit overall because they have those limited or even nonexistent borrowing histories. The Political and Economic Research Council puts the number of people in America with no credit standing at 54 million – a staggeringly high number. A person could pay their electric bill on time and in full every month for a period of several years or more, and it would not make the slightest impact on their credit one way or the other. However, if they were to miss those payments for a few months and have the balance they owe sent to a collections agency, the damage to their credit standing overall would often be massive.
2) They lock out tens of millions of Americans
Most people who haven't borrowed before, or don't have any accounts in their name at present, will typically have a difficult time getting approval for an account that's going to provide them with good terms, no matter how up-to-date they are in paying their other bills every single month. This may be particularly problematic because they typically also have lower incomes. Asking any slim-profile, low-income consumer what kind of terms they get on, say, a credit card when they try to apply, will typically yield answers like, "high rates" and "lots of fees." And that's if they can get approval for their applications at all, which doesn't happen as often as those people might like. For many Americans, they'd rather go without than pay exorbitant fees or rates, which only continues the cycle of their lack of credit access.
3) They're unfair
It doesn't make a lot of sense that people who can make all their payments every month should have low credit scores and slim profiles just because they're not making the "right" kind of payment for lenders. Certainly there is a science to managing a credit card properly, especially as it compares to any sort of installment loan. But the fact of the matter is that an installment loan probably shouldn't be looked at any differently than rent (in that it's a set price every month for which consumers must prepare), and credit cards aren't necessarily all that different from utilities bills (costs are based on how much the account was used in a given month). And yet traditional credit scoring companies only consider loans and credit cards when setting ratings.
4) They're outmoded
Another issue is that, by this point, with alternative credit scores having been around for so long, the industry knows that more information is going to paint a clearer picture of consumers' creditworthiness. Studies conducted within the industry itself have proven this to be the case. And yet the old credit score models – the ones that don't include the other payment data – continue to reign supreme within the industry, largely because those that created traditional credit scoring have a vested interest in not changing. They may be behind the curve, and they may know it, but they still don't have a lot of incentive to alter their course at this point.
Maybe all of this will change in the future, and allow consumers with limited incomes to gain access to reasonable and affordable credit. However, until that happens, it might be wiser for lenders to start issuing credit based on alternative credit scores – including those from PRBC – to get a more complete understanding of just how well these people can handle their bills overall.