Millions of Americans lack credit scores or have scores that are too low to gain access to affordable credit. This problem disproportionately affects young people, African-Americans, Latinos and immigrants, many of whom can't establish a credit score without taking on debt. Congress can help address this issue by providing companies with affirmative permission to thicken credit reports with predictive alternative data.
According to the Consumer Financial Protection Bureau, at least 45 million Americans cannot access affordable mainstream sources of credit because they either have no credit report or have insufficient credit histories to be scored. These Americans are known as "credit invisibles." They encounter difficulties when trying to rent an apartment or to take out a loan to obtain low-cost consumer credit.
But there is a solution. Many credit invisibles regularly make payments on their gas, water, electric, heating oil, cable TV, broadband, wireless cellphone bills and pay rent on their apartments or homes. These payments are recognized as credit and predictive of risk. However, this payment information is typically reported to a credit bureau when the customer is in collection not when people pay their bills on time.
Reporting this alternative payment data would substantially reduce credit invisibility and enable an estimated 40% of credit invisibles to qualify for some variant of prime credit. According to research by the Policy and Economic Research Council and the Brookings Institution, using a sample of more than four million actual credit reports with fully reported nonfinancial payment data, simulations showed that the inclusion of the nonfinancial data would enable credit acceptance to increase 22% for Hispanics, 21% for African-Americans, 21% for the lowest income households, and 14% for people under 25 years old and those over 66.
While these increases seem large, one should consider that the CFPB has found that 28% of Hispanics and African-Americans and 45% of individuals in the lowest-income census tracts are unscoreable with traditional credit scores and data. Credit reports that take into account when people pay their bills on time help the Americans who need credit the most.
I am now championing legislation in Congress which would clarify that energy utility firms, telecommunications companies and property management firms and landlords can report on-time payment data to nationwide credit reporting agencies. While such reporting is not illegal, regulatory uncertainty has hindered its practice.
My bill, the Credit Access and Inclusion Act of 2015, enables the addition of positive payments. There is nothing in the bill that would require or incentivize utility companies to start reporting late payment differently.
A recent op-ed by Chi Chi Wu published in American Banker cautioned that there may be pitfalls to using alternative data to help credit invisibles. However, my proposal would greatly benefit underserved Americans. Here are five substantiated and incontrovertible facts about how alternative data can help promote access to credit.
Fact #1: The status quo harms credit invisibles. Credit invisibles currently have their credit needs met by pawnshops, payday lenders and check-cashing services. These Americans pay an estimated $4 billion per year in fees, further entrenching their financial difficulties.
Fact #2: Credit scoring has made lending fairer and more inclusive. Study after study shows that automated underwriting better predicts risk than manual underwriting, and is more inclusive for traditionally underserved populations.
Fact #3: Reporting bills paid on time makes the system more forgiving and more inclusive. The nature of the problem is not that credit reporting and credit scoring are inherently discriminatory and promote exclusion, but rather that our national credit bureaus only have information on people who are already banked. Therefore credit scores are limited as a tool for promoting financial inclusion. In short, the problem is one of data, not discrimination.
Fact #4: Having a low score is better than no score. If you are a credit invisible, you will almost always be denied access to affordable credit. In this context, having any score even a low one is superior to having none at all. The notion that having no score may somehow be helpful in finding an apartment or employment or getting a more affordable insurance rate is also highly contestable. When applying for insurance, an apartment and a job, a credit report is one piece of information considered among many others.
Fact #5: Predatory and subprime lenders already seek data on credit invisibles. It is mainstream lenders who tend to overlook this population for prime offers and in traditional underwriting. To create a two-tiered system in which alternative data is used only for the otherwise unscoreable, as suggested in Wu's op-ed, is a bad idea. One tier would be reserved for mainstream lenders offering competitive loans serviced by the main credit bureau databases. Another tier would be designated for higher-priced niche lenders that use special databases to market to the credit invisibles. Not only would this segregate society, it also would result in consumer confusion and erode important consumer rights and protections. Therefore we should strive to bring all consumers into the same mainstream lending system where possible.
For all of these reasons, it is important that Congress provide affirmative permission to add on-time utility and telecommunications payment data to credit reports and scores. This would open up credit, housing and employment opportunities for tens of millions of Americans and make our current credit system more inclusive and accurate.
Rep. Keith Ellison is a member of the House Financial Services Committee.