Lenders have a new tool to help increase access to credit for the underserved and provide it on better terms.
Experian announced in January that it had begun including positive rental payment data in consumer credit files, opening the door to millions of consumers who lack a credit score or whose credit has been damaged in the recent economic downturn.
The move puts renters on par with homeowners in that they can now get credit for their timely rent payments. One-third of the U.S. population rents, and that figure will likely grow in the wake of the foreclosure crisis, the recession and the rethinking of federal housing policy.
Credit scores have become the entry ticket not just to loans, but also to bank accounts, jobs, apartments and insurance. As many as 50 million Americans have no credit record or have so little credit history that it is insufficient to generate a score, effectively shutting off access to mainstream credit markets. Those who do manage to find a willing lender are almost certain to pay more.
Many different groups of people are left out of the credit reporting system. They include immigrants, cash-based consumers and widows whose spouses were the primary account holders. Young adults have always faced the chicken-and-egg problem of establishing credit without a credit history. They are more challenged today because of the new restrictions on credit cards for those under 21 and because they are less likely than previous generations to be connected with a traditional bank.
The absence of a credit score doesn't mean a consumer is necessarily a bad risk. It just means there isn't enough information to make a judgment. Including rental payment data in credit files gives lenders more information to assess creditworthiness. This is increasingly important given the new requirement that credit card lenders underwrite applicants based on their ability to repay.
The opportunity extends beyond underwriting. "No file" consumers are harder to serve because they can't be found in traditional marketing lists. Adding nontraditional data to credit files puts more consumers on the map.
Experian gained access to the rental payment data last summer when it purchased RentBureau. The Atlanta-based startup had built a database of approximately 8 million renters by working with large property managers across the country. It turns out that a third of the renters had no formal credit history. Experian has since created new credit files for them.
This rental data also can provide a boost to consumers whose credit scores have taken a hit as a result of a foreclosure or other financial traumas brought on by the recession. For those who already had a credit file with Experian, the addition of the rental data led to meaningful significant credit score increases using the VantageScore model. One in three consumers whose score was in the lowest band, 501 to 600, moved up to at least the next level, between 601 and 700. A VantageScore of 700 is entry-level prime for some lenders.
Rental payment history is just one source of nontraditional credit data shown to have predictive value. Experian and others have been working for years to gather and include records of utility and cellphone payments, remittances, prepaid card transactions and a wide array of other information as a way to reach emerging markets.
A 2006 study by the Political & Economic Research Council and the Brookings Institution demonstrated the efficacy of including energy utility data in all consumer credit reports.
Doing so increased the overall acceptance rate by 10%, given a 3% target default rate. Including alternative data was especially beneficial for minorities and lower-income groups. For instance, the acceptance rate increased 22% for Hispanics, 21% for African-Americans, 21% for those earning $20,000 or less a year and 15% for those earning between $20,000 and $29,999.
A cottage industry of data and analytics firms — RentBureau among them — took shape over the last decade around the idea that day-to-day financial transactions can be predictive of credit behavior. They were beginning to get traction with lenders when the financial crisis hit and the appetite for reaching new markets dried up.
However, the financial crisis also demonstrated that traditional credit scores are limited in their effectiveness, especially in a time of major flux, when long-standing patterns of consumer behavior shift.
Alternative credit data was instead put to use in portfolio management, sorting out which consumers were likely to default in the wake of the financial crisis.
Now that the economy is beginning to rebound and lenders are beginning to think about customer acquisition again, it is time to revive the dialogue around the use of alternative credit data. Experian's move has provided a jump-start.