What is Alternative Credit Data?  There are many myths.

In the U.S. today, financial institutions chiefly use traditional sources to make their lending decisions.  TransUnion, Equifax and Experian. Think payment histories on installment loans and revolving lines of credit.  Having said that, there are now many other data sources available that lender might use to evaluate your creditworthiness.  These new sources are now being called “Alternative Credit Data.

Alternative credit data provides lenders with additional insights about the way you pay your bills, such as your cell phone, utility and rent payments.  Think about this. Although for some, alternative data might be supplemental, but for millions of people, it might be the only credit record they have. Although traditional credit has been reliable for a long time, alternative data is coming up more and more in discussions with lenders when they’re determining candidates’ creditworthiness.  

There are, however, some myths surrounding alternative credit data.  Read on.

Myth No. 1: Banks are using your social media accounts to evaluate your creditworthiness

There are two myths surrounding alternative credit data.  Many consumers believe that U.S. banks are using their social media profiles to evaluate creditworthiness, and that’s simply not true.  Under U.S. law, the Fair Credit Reporting Act (FCRA) mandates that lenders must explain to the consumer why he or she was rejected for credit. These rejections are called “adverse actions” and are highly regulated.  Rejecting someone for credit because they posted too many dog photos is going to raise a lot of concerns with compliance officers, regulators and the public. When you have to explain why someone was rejected for credit and you’re using traditional credit data, the explanation is simple.  The consumer doesn’t meet some FICO score threshold. Lenders must provide clear explanations why consumers aren’t creditworthy and with alternative data, the adverse actions can be complicated. Rejecting someone for credit because they posted too many dog photos is going to raise a lot of concerns with compliance officers, regulators and the public.

Myth No. 2: Alternative credit data is growing quickly

Another myth about alternative data is that it will be used much more going forward.  The future for the integration of alternative credit data doesn’t seem to hold much promise, because progress has been slow.  PRBC and RentBureau (now with Experian) are among the major pioneers of alternative credit data, and they were created 14 years ago. And rental payment histories have yet to be impactful on a consumer’s perceived creditworthiness.  In addition, many consumers think they’ll soon be able to rely on alternative credit data to qualify for new credit lines, and that’s not true, Zhen said. The future for the integration of alternative credit data doesn’t seem to hold much promise, because progress has been slow.  The majority of FICO scores don’t even use alternative credit data as part of the calculation. Which, Zhen feels, means consumers may be wasting money and effort to establish rental payment information and billing histories with utilities and insurance policies (Experian Boost, unlike UltraFICO, takes into consideration payments to insurance companies).  Again, neither will matter if lenders don’t actually use them for the underwriting process. Sure, consumers can offer to supplement their credit and loan applications with the alternative credit data, but there is no guarantee that lenders will integrate this information as part of their underwriting process.

Myth No. 3: Alternative credit data is widely used

The biggest myth surrounding alternative credit data is that it is already being generally used by lenders.  The use of alternative credit data in credit scores is actually still in its infancy. While unpaid utilities, rent and cell phone bills that are sent to collections will have a negative impact on your credit scores.  Your positive payment activity is not factored into the primary in use scoring models. For example UltraFICO, is a new scoring model that considers alternative data (borrowers’ checking, savings and money market account information), has yet to be fully rolled out.  Lenders simply aren’t extensively using other released models that consider alternative credit data. For example, lenders have not been quick to adopt the FICO Score XD, another model that takes into consideration the borrowers’ nontraditional data, such as cell phone payment records and utility bills.  Newer models such as UltraFICO and Experian Boost allow consumers to voluntarily offer alternative information for credit scorers and lenders to consider — including balances in their checking, savings and money market accounts — along with their normal credit reports, for a chance to improve their credit scores.  While unpaid utilities, rent and cell phone bills that are sent to collections will have a negative impact on your credit scores, the positive payment activity is not factored into most scoring models. When consumers hear about alternative credit data that might build their credit, they believe it will help them in every circumstance.  Not all lenders are willing to adopt credit ratings based on alternative credit data. Even with the new UltraFICO, which permits consumers to add alternative activity to their credit data, not all lenders update to the most recent FICO score.

Myth No. 4: Alternative credit data isn’t reliable

Another myth about alternative data, is that it’s unreliable in terms of the information being provided.  Given that it is recognized under the Equal Credit Opportunity Act (ECOA), and the data provided is garnered from legitimate business sources such as utility companies, banks and mobile service providers, there is no valid reason to discount the accuracy of the information.  Another misguided concern about alternative credit, is that those who are “credit invisible” are not creditworthy or that they present a risk to lenders. If an individual can demonstrate the ability to pay important items such as their rent and bills on time, along with successfully managing their money in their day-to-day banking activities, it is evidence of fiscal responsibility that a potential lender can interpret positively.

Myth No. 5: Alternative credit data counts only for consumer financing

Many people think alternative credit data is important really only when it comes to consumer financing.  But that’s not true. Online lenders in the small business space were some of the first to tap into alternative credit data when the Great Recession happened, and banks stopped lending to small business owners. These online lenders — such as OnDeck, Kabbage, and QuarterSpot — don’t place too much emphasis on small business owners’ credit scores. Instead, they look at trends in a business’ annual revenue, which is often a stronger indicator of a company’s success and growth potential.  For example, QuarterSpot provides up to $250,000 in funding for small business owners with a credit score of 550 or higher, as long as the company is making at least $200,000 in annual revenue. A business owner might have poor personal credit because they didn’t manage their personal finances well, but they could have a rapidly growing business on their hands. Those two things are separate to some extent, and that’s what alternative credit data captures in the small business lending space.”

Alternative credit data.  Don’t be concerned. There aren’t many drawbacks

Although traditional credit data has reigned supreme for lenders to use when making credit decisions about consumers, alternative credit data can give them deeper insights into how people are really managing their money.  For those who have been overlooked for credit because of their traditional credit data — or lack thereof — alternative data can be an important source of intel that might translate into credit approval. Not only does alternative credit data provide lenders with a more personal look into their consumers, but it also gives consumers who are seeking credit a greater way to build their cases for approval.  The future of alternative data as a key underwriting tool is uncertain, but it has the capacity to serve as another valuable source of information that could help lenders avoid risk — and help consumers meet their financial goals.