The Consumer Financial Protection Bureau (CFPB) is weighing relaxing federal regulations to allow more lenders to consider nontraditional information when weighing a consumer’s creditworthiness.
As part of its review, the CFPB is seeking public feedback on the benefits and risks of using unconventional sources, such as cellphone payments or checking account information, to help the roughly 45 million Americans who lack a full credit file.
“Credit scores play a central role in the financial lives of American consumers,” CFPB Director Richard Cordray said in prepared remarks. “Unfortunately, for many consumers with a limited or non-existent credit history, a credit score is out of reach.”
Alternative data could make it easier for some consumers to obtain credit. However, it could also make borrowing more difficult for consumers who have strong credit scores but are weighed down by other factors – such as missed utility payments or frequent address changes – that aren’t traditionally found in credit reports.
Critics also worry that incorporating nontraditional data could lead to unintentional discrimination or to negative credit decisions based on incomplete or inaccurate information.
What is the nontraditional data lenders might consider? This includes cable, phone, utility and rental payments, checking account transactions, and job and education history. But that’s just a start.
“New forms of alternative data may come from sources that never existed before, such as the way we use our mobile phones or the Internet,” said Cordray. “By filling in more details of a consumer’s financial life, this information may paint a broader and more accurate picture of their creditworthiness.”
Nontraditional data also might help identify consumers who are more worthy of credit than their FICO scores indicate.
“Consumers who experience a financial hardship – such as the loss of a job or a large medical expense – may fall behind in making credit payments,” said Cordray. “This may tag them with a low credit score long after their financial situation has turned around.”
It typically takes up to seven years, for example, for a missed loan payment to drop off a credit report. “These people should not be held back simply by their retrospective credit score,” said Cordray.
The CFPB stressed it would examine the potential pitfalls of incorporating nontraditional credit data.
In addition to concerns about privacy and the accuracy of nontraditional credit information, Cordray said the agency is especially worried that incorporating more data into credit decisions could lead to widespread consumer confusion — especially if a huge number of data points are used to make a decision.
“The credit process can already be somewhat murky. So we want to learn whether folding in alternative data could complicate the decisions facing consumers,” said Cordray. “The harder it is for consumers to understand their credit record or whether they are likely to qualify for certain loans, the harder it will be for them to master their finances.”
Already, a wide range of lenders are testing or incorporating nontraditional data, making underwriting significantly less transparent. As I’ve written about previously, around the same time that credit card issuers began offering free credit scores to consumers, many lenders began quietly testing and incorporating alternative sources of information.
As a result, consumers’ understanding of what truly affects a lender’s credit decision continues to be shrouded in mystery – despite the fact that it’s easier than ever now for consumers to learn about their traditional credit scores.