EQUIFAX, ONE OF THE THREE LEADING PROVIDERS OF CREDIT INFORMATION, released news last week of a new credit scoring model designed to help people with nontraditional forms of credit obtain a credit score. In a joint announcement with LexisNexis Risk Solutions, Equifax said they will initially pilot 12 of the nation’s largest card issuers to use alternative data to identify creditworthy individuals who are unlikely to otherwise obtain traditional credit.
FICO data scientists have determined that alternative sources of data — such as property records, telecommunications and other utility records — can be reliably used to score 15 million consumers who do not have enough credit data to generate a FICO score.
“Working with Equifax and LexisNexis, we set out to help unbanked, under-banked and disadvantaged people gain equal access to the standard credit products enjoyed by millions of Americans,” said Jim Wehmann, FICO’s executive vice president for scores. “We’re excited by our pilot program’s strong results thus far. FICO’s focus is on expanding access to credit, not simply scoring more people. Our approach also addresses a paradox for people seeking their first traditional credit product — you often need a credit history before you can get traditional credit.”
Whenever anybody in lending begins to speak about alternative qualifying methods, there is an uproar of people saying the often-heard phrase: “Here we go again.” Let me assure you, this is not a “here we go again” moment — at least not yet.
It is, however, an attempt to fix a problem created by the credit scoring system. As Mr. Wehmann explained, “you often need a credit history before you can get traditional credit.” The problem is that credit scoring has created automation: It is no longer necessary for a physical underwriter to evaluate credit, because very sophisticated computers have proven to be far more effective at evaluating credit risk. Not always perfect, to be sure, but certainly more reliable.
As a result, people who have never had credit or have not used credit in a very long time do not have enough information in their credit files to create a score. So it is the old problem of the chicken and the egg. You need credit to have a score, but you can’t get credit without a score.
In real estate lending, lenders have used “alternative” credit as a basis for evaluating credit risk for many, many years. The unfortunate truth is that evaluating a borrower based on alternative credit does create more risk for a lender, and as a result there are only a limited number of lenders who will accept this risk — and the ones who do will charge the borrower higher rates and fees as a result of the increased risk. This is a double whammy for consumers, as they have less choice and must pay more. So in this sense I can see where developing a score for borrowers who don’t typically use credit could be a big benefit.
Keep in mind that there are numerous credit scoring models. Different types of lenders use different scoring systems. I have not heard anything from Fannie Mae or Freddie Mac about this program, but experience tells me that it will be a long time — if it ever happens at all — before these mortgage giants feel comfortable enough with this model that it is regularly accepted in home loans.
However, for the consumer who wants to build a regular banking and credit relationship, this could be of tremendous assistance in getting established and building enough credit that they would no longer need the alternative score. For these consumers, this could be a great opportunity.
Guy Benjamin (CAL BRE License #01014834, NMLS 887909) writes a weekly column for The Herald, offering general information on real estate matters. As it is impossible to address all possibilities and variations, he will try to answer individual questions by readers who contact him at 707-246-0949 or guyb@fairwaymc.com.
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