Until recently, the ability of most Americans to gain the attention of lenders or real estate brokers depended largely on their credit history. It didn't matter if you lived in the same residence for years, held a steady job, or paid your bills on time, every time. The major credit bureaus relied only on the amount of credit you had, determined through your number of credit cards, how often you used them, how regularly you paid, and so on. This put individuals without credit cards, or lacking extensive credit histories -- usually young students, minorities, and the like -- at a distinct disadvantage.
Now credit and finance companies like MBNA are watching profits fall as debtors pay down their balances. So, seeking new business, the finance industry is aggressively courting the "thin credit" markets it previously shunned.
Many "nontraditional" models of credit scoring have been put into practice by lenders, emphasizing rental and utility payments, as a way of gauging a customer's ability to pay their debts.
As financial analyst Josh Kessler recently stated in an article on the "thin credit" market, "[I]n fact many potentially creditworthy bank customers have paid for things only with cash -- by choice or by circumstance ... To sustain growth and profitability, financial services institutions can't ignore this large and growing credit base."
On its face, this presents a golden opportunity for many potential home buyers and credit seekers to take advantage of the real estate market before the real estate bubble bursts. It can provide them the opportunity to develop a credit history doing what they'd do normally -- pay their bills -- without falling into the many traps and problems using credit cards can bring.
But it can also open up an entirely new class of consumer to predatory lenders and unscrupulous creditors, as well as risking the loss of even more personal data to "information brokers" and identity thieves. As Americans grow increasingly savvy regarding credit cards and use of personal data, more attention needs to be paid to the use of "alternative" scores, and the consequences of relying on them.
According to research performed by the Fair Isaac Corporation, as many as 50 million Americans may have little or no credit history, placing them in the ranks of the "thin credit" files or "unscoreables." Traditionally, consumers with small or no credit files fall into the ranks of low-income generators or people new to the credit system, such as students, young adults, recent immigrants and ethnic minorities.
The burgeoning Hispanic immigrant population is of particular interest to the financial services market, according to the National Council of La Raza, which notes that Hispanic purchasing power has been rising at an extraordinary rate, now exceeding $585 billion annually, nearly triple the 1990 level. However, that does not translate instantly into credit history, as La Raza notes that many Hispanics are averse to taking on debt or buying things they can't afford.
Kessler says as much in his essay: "[T]he surging immigrant population -- especially Hispanics -- who arrive either lacking credit histories, or being culturally predisposed to paying by cash or check."
Many young homebuyers and newly immigrated families are being bedazzled by the constantly falling mortgage rates in the housing market, and are often convinced to put down payments on houses they cannot afford, using dangerous interest-only or "adjustable mortgage" loans, all without any serious credit history or evidence of loan payments to back them up.
"Subprime" lenders who target minority and "thin credit" buyers find they are able to charge interest rates of 8 to 12 percent, far above the current rate of 6 percent for those with established credit. Many members of the "thin credit" category make incomes barely above minimum wage, and often run the risk of foreclosure or bankruptcy if they fall behind in their payments even once or twice.
Just as often, though, many "unscoreable" citizens make a solid income, pay all their bills, and regularly put money into investments. However, since they prefer to use cash, write checks, or use debit cards for point-of-sale (POS) transactions, they do not develop credit histories that can be tracked via regular credit card bill payments. (Debit card purchases do not record as usage of a credit card, and credit agencies do not monitor debit transactions as a rule.)
Further, as rental prices continue to stabilize or fall even as housing prices rise, a larger percentage of the employed will continue to rent, thus denying them the ability to base a mortgage loan rate on their loan history or credit rating.
Economists and financial analysts are, unsurprisingly, given to conflicted opinions regarding the "unscoreables" and how to bring them into the market. In a widely syndicated Washington Post column, Kenneth Harney extolled the virtues of alternative credit scoring as a "breakthrough". By contrast, MSN Money financial adviser Liz Pulliam-Weston advocated relying on the traditional models of building and maintaining credit, such as establishing and maintaining a credit card, applying for a small loan, etc.
"The traditional ways of establishing credit history are still the best. They'll cost you less and ensure you access to a broader array of potential creditors," she wrote.
New Options for New Beginnings
In July of 2004, the Fair Isaac Corporation, creators of the FICO score model, unveiled the FICO Expansion score as a means to build credit histories for "underserved" consumers in America. Fair Isaac touted the Expansion score as a way for beleaguered lenders to pursue the "Holy Grail" of new markets via the "thin credit" consumers.
"US lenders are competing ever more fiercely for the same set of consumers, resulting in eroding profit margins and reduced shareholder value," according to Fair Isaac's statement regarding the Expansion score's value to lenders. "These banks compete aggressively with each other, resulting in more credit options for consumers, but ultimately lower profit margins for lenders The FICO Expansion score helps lenders break away from this cycle by confidently expanding into previously untapped population segments."
The Expansion score follows FICO's model of analyzing data regarding the consumer, using the corporation's "analytic methodologies", and generating a 3-digit score based on criteria assembled from "nontraditional" sources, such as utility bill payments, usage of "payday loan" centers, and the like. Interestingly, the Expansion score does not use rental payments as a criterion for creating the score, as that is not considered a sufficient enough gauge of a person's ability to pay their debts.
The Expansion score also utilizes elements of FICO's Qualify score, designed to target pre-screened credit offers. This information includes such disparate sources as state vehicle registrations and Nielsen Media survey members. How one's television-watching habits are a more accurate predictor of loan repayment ability than rental payments is undoubtedly one of FICO's closely guarded trade secrets.
A nontraditional score that does incorporate rental payments into its model is the Anthem score, created and marketed by the First American corporation, already famous for the REGISTRY database of rental information and the SCOREX system of scoring rental applications, discussed in ConsumerAffairs.com's February 2005 article on rental screening.
The Anthem score follows traditional scoring models, but incorporates data from a wide base of sources, ranging from rental and utility payments to "non-deductible insurance payments" and "regular child-care expenses". The Anthem score was apparently reliable enough to impress Massachusetts-based housing and lending agency MassHousing, for they adopted their score as a tool to underwrite loans in April of 2005.
Although MassHousing is (as of this writing) the only lender to directly utilize the Anthem score, but lenders ranging from American Mortgage Corporation to Bank of America are observing and studying its use for possible adoption into their own underwriting practices.
Another major player in the "thin credit" market is eFunds. The Scottsdale, Arizona-based "financial services" corporation should be familiar to ConsumerAffairs.com readers as the parent company of the ChexSystems banking clearinghouse. eFunds created and controls the DebitBureau database, containing "more than 3 billion records related to checking and savings account opening and closing information, checking account collections data, overdraft histories and check order histories," as of August 2001.
eFunds also integrated the DebitBureau database into its Debit Report suite, which combines with ChexSystems reports to provide a comprehensive history of a person's payment, spending, and lending habits, all without ever touching a credit card.
DebitBureau also conveniently integrates into the Penley ID Verification software system, marketed by eFunds as an identifying tool for possible money laundering through financial institutions, and used by the government as a tool to enforce the PATRIOT Act's provisions on sharing financial data and maintaining compliance with the Office of Foreign Assets Control (OFAC), as was reported by ConsumerAffairs.com last month in its article, USA PATRIOT Act Rewards ChoicePoint, Other Private Databases.
A particularly innovative approach was developed by the newly-minted PRBC (Payment Reporting Builds Credit, formerly "Pay Rent, Build Credit") credit reporting agency. Based in Annapolis, Maryland, PRBC uses rental and utility payments to create a "report card" that grades users on a scale from A to D, highest to lowest.
The "weighted" approach of the scorecard places highest emphasis on lease and mortgage payments, followed by utility and auto payments. PRBC's stated mission of "help[ing] you build an accurate bill payment history with your rental, utility, and other recurring bill payments."
According to PRBC's founder and CEO, Michael G. Nathans, "it's a completely voluntary system. Users can opt in and opt out any time they wantconsumers can list anyone they're using to pay bills with our service."
PRBC employs a host of tools to educate consumers and provide them access to credit opportunities they might otherwise lack, including education partnerships with consumer lending organizations ranging from La Raza to the Fannie Mae Foundation. In addition, it enjoys a "preferred partner" status with the mortgage division of financial services giant Citicorp, and recently collaborated with credit software solution provider Luxor Technologies to provide PRBC's data scores to the three largest credit reporting agencies, Equifax, Experian, and Trans Union.
However, Nathans claims that though PRBC makes money via selling consumer credit files as other bureaus do, they do not sell mailing lists for pre-screened credit offers, and make every effort to aid lenders in "finding customers who can be part of the system ... we're holding ourselves to a higher standard."
The common wisdom holds that the major credit reporting agencies did not consider "nontraditional" modes of payment as valuable criteria, thus the necessity of alternative scores and systems. However, many data brokers and resellers have been tying lending and renting assessments to credit scores for quite some time, albeit out of the public eye.
The SCOREX rental "risk assessment" score, for example, was originally created by Experian, and though the First American corporation uses a proprietary, modified version of it for their purposes, the system still relies upon Experian credit reports when conducting "screens" of potential tenants.
eFunds solicited Experian in a partnership combining the DebitBureau records with Experian's "offerings that include prescreen segmentation and suppression, emerging consumer identification and assessment," thus granting the credit giant access to millions of potential new markets for pre-screened offers, even if the customers in question did not have credit cards.
Many major utility and service companies take it upon themselves to provide customer payment records to the credit bureaus as a "service." Verizon recently notified its customers that it sends their payment histories out in order to promote "good billing habits." Financiers and credit companies will, in turn, mine this data for any sign of late or missed payments, and increase the interest rate or minimum payments on particular cardholders as a result ... even if they've paid their credit card bills on time, every time.
This practice, "universal default," is a favored tactic of major credit card issuers, such as MBNA, as previously reported by ConsumerAffairs.com (MBNA Turns Up the Heat).
Even with these tactics in place, the "thin file" market (and, as Michael Nathans calls it, the "thick derogatory file" market) is difficult for the banking and finance industry to penetrate.
In a May 2002 response to the Office of Thrift Supervision's request for commentary on financial information sharing, Capital One emphasized the importance of using consumer information to get a foothold in the "nontraditional" credit market:
We would not be able to offer the diversity of products to people with thin credit files (credit files that contain little or no information) ... It would be too risky for us to offer certain products without having access to the customer's favorable transaction and experience information We would not be able to tailor products for specific consumers because we would be unaware of credit capacity, buying preferences, and special circumstances, (e.g., offering home equity loans or renter's insurance to the customer who has just moved or owns a house)Our cost of doing business would increase.
In his article on nontraditional credit scoring, Kenneth Harney quotes Michael Turner, president and senior scholar of the Information Policy Institute, as saying "State utilities regulations often restrict or prohibit dissemination of consumers' payment records ... so the single best data source may be difficult to access without regulatory changes at the state level."
The Institute also recently published a paper advocating the notion that Western and European nations' laws guarding data privacy were a threat to corporations' ability to effectively network their data to outsourced operations in the Middle East and India:
Unfortunately, privacy regulators in advanced economies, in their zeal to protect data privacy, are on course to prevent an economically efficient and politically expedient solution to the problem of addressing unmet labor needs where immigration is not an issue.
The Institute is ostensibly "[i]ncorporated as a non-profit organization ... expressly non-partisan in outlook, and seeks to advance public policy through the judicious application of academically rigorous analysis." However, given that some of the Institute's funding supporters are MBNA and the major credit bureaus, a certain degree of skepticism concerning the Institute's aims needs to be maintained.
Building Your Future, One Bill at a Time?
Housing rights organizations and consumer rights groups are advocates of nontraditional credit scoring because it gives those who might not otherwise have a chance at owning a home an opportunity to get in on "the American Dream."
Michael Nathans specifically derides the usage of the word "nontraditional" as "stigmatizing consumers, usually Black or Hispanic ... they don't want to be perceived as different. Everyone starts out the same." That "stigma" can be the key many unscrupulous lenders will use to charge exorbitant interest rates to "thin file" consumers who just want their own place to live.
Unquestionably, the opportunity to gain credit for loans and purchases can be a benchmark for any individual's financial future. However, as the massive increase in "subprime" home loans leads to increases in foreclosures, bankruptcies, and debt, and as creditors find their profits falling by consumers paying off their cards, the "nontraditional" market may be a golden egg for corporate profit, and a poison pill for anyone who isn't paying attention to the fine print.
One thing it is not is a "quick fix" for anyone who has credit problems. Cate Williams, vice-president for education at the Money Management International credit counseling service, said it best in an August 2004 Bankrate.com article:
"This isn't the great fix for those who have charge-offs or a poor payment history ... "It rewards people who weren't in the credit market, or preferred not to be in the credit market. Believe it or not, some people don't like credit."