New, Alternative Credit Scores Help Borrowers
More-flexible criteria especially benefit millennials and retirees.
Gerri Detweiler (pictured at left) is head of market education for Nav, a website that helps entrepreneurs build and manage business and personal credit. Here's an excerpt from our recent interview with Ms. Detweiler.
SoFi, a company that offers student loan refinancing, mortgages and personal loans, will no longer use FICO scores to determine a borrower’s credit risk. Other lenders have indicated they may also develop their own scores. Why is this happening? One of the frustrations with the FICO score and the score of its competitor, VantageScore, is that someone who is financially healthy might not have a good score—not because they’re doing anything wrong, but because they’re not very involved with credit. Maybe it’s someone older who has paid off everything, or someone young who hasn’t had a chance to build credit. Interest in alternative data comes from a desire to bring more borrowers in.
What do traditional credit scores miss? They may miss responsible financial behavior that doesn’t show up in most credit reports. For example, many millennials shy away from credit cards. A millennial who doesn’t have a credit history may be using debit cards very responsibly. And a retiree could have a lifetime of good credit but no longer needs to borrow. Both may be paying rent as well as insurance, Internet or cell-phone bills, none of which boosts traditional scores.
SoFi said it will consider savings, cash flow and future earnings when deciding whether to issue credit. Should consumers be concerned about such alternative criteria? We have strong regulations around credit record data with regard to a traditional credit score. For instance, if you get turned down for a loan, you have the right to see the score. The rules are murky with alternative data. That’s why alternative data are used more robustly in small-business lending as opposed to consumer lending, where regulations are stricter.
Can consumers stop worrying about their FICO scores? Absolutely not. A large majority of lenders for credit cards, cars and mortgages are still using FICO and VantageScore numbers. Alternative scoring is still a subset of what’s going on in mainstream lending, which covers 90% of consumer loans.
How can people build a good credit history in this environment? Use accounts that report to traditional credit bureaus, keep debt levels low and pay on time. Getting a credit card is still one of the fastest and easiest ways to build credit.