Without a viable credit history, lenders won’t be able to judge whether or not you are a credit risk. The traditional means in which a credit score is formed starts by analyzing your credit history. However, lenders are starting to find new data that can help shed light on someone’s creditworthiness if they don’t have a robust credit history. This “alternative data” can be used to help lenders determine how risky you are.
What is considered alternative data?
To form a traditional credit score, data regarding how you have handled credit and debt in the past is taken into consideration. This data is compiled by Equifax, Experian, and TransUnion. From that point, the data is used to create a credit score by companies like FICO and VantageScore according to the article “Credit Challenged? How Alternative Credit Data Can Help Those with Little or No Credit.”
If you haven’t had much experience with credit or debt, then other sorts of data can be dug up, which can include “how reliably you’ve paid rent, utility payments, and rent-to-own agreements.” However, data that is outside of payment transactions is also accumulated.
According to the LexisNexis Risk Solutions, the data that they collect has the ability to predict one’s creditworthiness. With this new data, it can help credit bureaus score approximately 40 million consumers that would have otherwise been too difficult to score. LexisNexis Risk Solutions has paired with FICO and Equifax so to bolster traditional credit bureau data. This new kind of credit score is called the FICO Score XD.
FICO and TransUnion have stated that this new form of data has allowed them to score previous applicants that weren’t score-able. For FICO, it allowed them to score more than half of all previous applicants that they could not score; a third of these applicants were found to have a FICO Score XD of 620 or higher. For TransUnion, it has resulted in the approval of 20 percent more applicants than they could before.
Alternative data is still new
The goal of using alternative data is to open lenders up to a larger customer base. In using alternative data, they can more effectively determine if those with the absence of a credit history, or with a very short history, are indeed creditworthy. However, this new form of data may take some time to fully catch on since many lenders still have not opted into using this it.
Moreover, one of the biggest concerns regarding alternative data is privacy and transparency. There are many people that would feel uncomfortable sharing this sort of information with financial institutions. And once more, a data breach is always a risk that needs to be considered.
Transparency is also a concern next to privacy and security. If people do not know what sort of alternative data is being collected to determine their creditworthiness, then how does one expect to adjust their behavior to make sure they get a good score? It is for these reasons that many consumer advocates are suggesting that individuals should be asked whether they want to opt into such a collection to begin with.
Alternative data can be a useful way to bridge the gap for those with little to no credit history but is clear that there are still many kinks that need to be worked out before this new product truly takes hold in the market.