The Catch-22 of credit — that you need it to get it — should not exist in this day and age when data galore is at our fingertips.
The use of alternative data, like rent and utility payments in credit decisioning – which industry professionals have been prophesizing about for years – should be more prevalent. Yet, millions of Americans continue to go without access to affordable, high-quality credit products, in part, because they lack a long credit history or do not have a credit history at all. This quandary could be at least partially resolved by the use of alternative data.
Some rental, utility and telecom companies report payment data, but not enough do. And the information that gets reported is usually negative, alerting the big three credit bureaus (Equifax, Experian and TransUnion) only when a consumer has been delinquent in paying a bill. Conversely, those consumers who pay their bills in full and on time every month are often unable to prove their creditworthiness since this positive financial behavior goes unreported. As a result, they may receive higher-priced credit or be denied credit by traditional lenders.
The Center for Financial Services Innovation has been studying the potential benefits of alternative credit data for several years. It is our belief that the use of alternative credit data has the potential to responsibly increase underserved consumers' access to high-quality credit products they can afford.
One of the reasons utility and telecom companies fail to report positive payment data to the credit bureaus is because many state regulators discourage it, leery of unclear federal regulations about the permissibility of doing so. Recently, two legislators have taken up this cause, introducing a bill to clarify that, under the federal Fair Credit Reporting Act, utility and telecom companies are permitted to report on the timely payment behavior of their customers to credit reporting agencies.
In September, the House Committee on Financial Services held a hearing to consider the merits of the proposed, bipartisan bill (H.R. 6363), known as The Credit Access and Inclusion Act. Introduced by Representatives Jim Renacci (R-Ohio) and Keith Ellison (D-Minn.), the bill is just one of the many ways to encourage more widespread use of alternative data and improve underserved consumers' access to high-quality credit products.
But this proposed legislation isn't just good for consumers. It has benefits for the financial industry, too. By having more rich data on consumers' payment history, financial institutions can better understand consumers' likelihood to repay. But, even more importantly, financial institutions can better reach the underserved market — which is a significant opportunity, considering there are 68 million financially underserved adults living in the U. S. today.
Many individuals without a lengthy credit history or credit score are creditworthy individuals. The Policy and Economic Research Council , a Durham, N.C. think tank, estimates that about 50 million consumers have credit scores that could be higher if utility and other alternative payment data was included in their files. PERC and the Brookings Institution also contend that including alternative data in consumer credit reports could place 40% of the currently unscoreable consumers into the prime category.
We recognize that not everyone shares our perspective on this issue. Some believe that full-file credit reporting is potentially harmful to consumers, because, in addition to the positive information utilities would report, a lot of new negative information could get reported. While we share some of these concerns, overall we believe this bill will have a positive impact on consumer access to high-quality credit.
H.R. 6363 is expressly not a mandate. It would simply clarify the landscape, thereby encouraging utility companies to report positive payment data. The need remains for a variety of affordable, high-quality credit options that meet the diverse needs of underserved consumers. After all, it may actually be in the best interests of lenders and consumers alike for financial institutions to provide some consumers a more limited credit offering because of full-file reporting..
Finally, credit reporting agencies are now, for the first time, being fully supervised and regulated by the Consumer Financial Protection Bureau, which gives us confidence that the consequences for consumers associated with adding nontraditional data will not go unnoticed.
Now is an opportune time to talk seriously about alternative data, considering how consumers' credit histories have suffered since the financial crisis. CFSI believes more research is warranted to show that alternative data can help a lender determine which consumers show positive credit behavior today, even though their traditional credit reports do not reflect as much. This would help both consumers and lenders, who can improve their bottom line with increased predictive ability.
H.R. 6363 advances the conversation about the power of alternative credit data — one of the many keys to increasing consumers' access to high-quality credit. The more the financial services industry and those who regulate it understand the potential positive ramifications of including alternative data in credit reports, the sooner we can eliminate the Catch-22 of credit.
Rachel Schneider and Rob Levy are vice president and manager, respectively, on the Insights and Analytics team at the Center for Financial Services Innovation.