Today, credit scores are necessary. Most of the institutions that offer student loans, auto loans and mortgages require traditional credit reports to figure out whether you, the borrower, can handle a loan.
Several years from now, this may not be the case. Millennial habits are forcing lenders to shift gears. While they pay rent, utilities and other monthly expenses, they stray away from credit cards and other forms of traditional credit. Their choices mean that banks, credit unions and other businesses don't have the data they would normally rely on to approve loans. Many lenders are using alternative credit reports to assess people's ability to pay back loans.
What is alternative credit data?
Alternative credit data tracks how diligently you pay regular monthly expenses such as rent, utilities, internet services and insurance premiums. Companies that collect this data (with your permission), run several calculations to produce a three-digit score similar to a traditional credit score and a detailed report showing you how well you manage expenses. Then, you can bring the score and report to alternative lenders like auto dealers, jewelry stores and electronics retailers to receive lines of credit or loans.
Depending on which alternative credit provider you choose, your score and report is free, and you can access it however many times you want. PRBC is one company that offers free alternative credit scoring, and its services are really easy to use.
But do banks, credit unions and other traditional financial institutions accept alternative credit reports? Many are testing the waters. They haven't jumped in the lake yet, but there's a chance they might if current conditions persist.
The problem traditional lenders face
Quite a few people in the U.S. either don't have credit reports or have so little data within their reports that lenders can't make accurate judgments on their financial character.
"63% of people aged 18 to 29 do not have credit cards."
According to the Consumer Financial Protection Bureau, there are about 45 million Americans who are credit invisible or unscored. For businesses that invest heavily in lending, this presents a huge problem. Many of those Americans may be financially responsible, but banks and other traditional institutions don't want to take a leap of faith when providing loans, as they could experience serious losses from doing so.
It doesn't look like there will be fewer credit invisible or unscored people in the future, either. A Bankrate survey showed that 63 percent of people aged 18 to 29 do not have credit cards, which means quite a few of them may have thin-file credit reports or no credit reports at all. Either that, or the data credit bureaus can collect misrepresents their creditworthiness.
In light of this credit invisibility situation, many lenders are calling for use of alternative credit data. In June, the National Association of Realtors sent a letter to two congress members suggesting that Fannie Mae and Freddie Mac be able to use nontraditional credit scoring models when assessing borrowers' creditworthiness. If Congress acts on this recommendation, alternative credit scores may have a stronger foothold in the mortgage industry.
Given that an alternative credit score will cost you nothing, it certainly doesn't hurt to get one, especially in light of the fact that many lenders are considering using such scores.