While credit scores may have a central role in deciding who qualifies for a given financial product at specific terms, let’s face it – the current credit system works against the financial inclusion opportunities of a disproportionate population of lower-income consumers who don’t even have enough credit data to make a fair determination.
To improve lower-income consumers’ access to credit with better, more realistic terms, such opportunities remain with credit unions that can leverage alternative data not found in traditional credit reports.
So who exactly are we talking about? By demographic, these consumers are disproportionately individuals of color who, by circumstance or choice, go about their daily lives predominantly using cash. Without the use of credit, their credit score barely exists, if at all, or they have subpar scores.
Situations like this can cause compound and historic inequities, disallowing those consumers from accessing true generational credit- and wealth-building opportunities through other financial products like homeownership, auto loans, or credit cards. About 54 percent of Black Americans report having no credit or a poor-to-fair credit score (or any score below 640), according to a 2022 Credit Sesame survey of 5,000 U.S. adults. Roughly 41 percent of Hispanic Americans also reported falling into this category.
Compare those results with 37 percent of White Americans reportedly experiencing poor credit circumstances.
“While the credit system was created to be blind, this data shows that Black and Hispanic Americans are being unfairly shut out of the system,” said Jay Moon, former General Manager of credit at Credit Sesame and current Executive Advisor at eSpark Learning.
With financial technology resources fully available to today’s financial institutions, employing more comprehensive alternative data could provide a launch pad to financial inclusion that allows many lower-income consumers a better, more detailed evaluation for credit opportunities.
Loan approvals – better for members, better for you
It’s a near-mystical word, “Approved.” Can you imagine the 77 million of your fellow Americans who have rarely heard that word? That number represents the American consumers who have been shut out of the traditional mainstream financial system because they had little to no credit history.
Do you have at least a good estimate of how many of your specific credit union’s members fit into this category? Just as importantly, how many times have you had to say no to one of those members asking for a much-needed personal loan, auto loan, or mortgage? An unenviable task, no doubt.
Now turn that task over and imagine being able to serve with confidence 96 percent of your member community the financial inclusion products and services they deserve, including those lower-income members with less-than-stellar credit. All your cooperative needs is access to and onboarding of the proper financially-inclusive alternative data tools and the perspective to look beyond traditional credit.
“How can I grow my credit if I can’t get credit?”
For so many consumers in the U.S., obtaining credit in the traditional financial system is a matter of which-is-first – to GET credit, you have to have a prior credit history. You can’t build a credit history, however, unless you have credit. What?
According to Equifax, almost a third of American consumers remain underbanked, unbanked, have a minimal credit file, or are outright credit invisible. Without mainstream or traditional credit, many consumers are automatically considered “unscoreable” – at least when employing traditional scoring tools – or they’re deemed “below prime,” even though they’re more than capable of working with credit.
Could a third of your credit union membership be struggling with this particular challenge? It’s a reality a good number of your members are dealing with, but certainly a challenge your staff can address directly and solve.
It’s true that traditional credit scoring is currently the dominant predictor of financial and economic performance for today’s consumer. But when financial tools are augmented with alternative data, that combination morphs into a much more comprehensive, ultra-inclusive resource that can score up to 96 percent of consumers, according to Equifax. Alternative data represents the detailed, day-in, day-out info that typically gets excluded from credit reports.
Grovetta Gardineer, senior deputy comptroller at the Office of the Comptroller of the Currency (OCC), emphasized at a virtual Urban Institute keynote event that millions of consumers without traditional credit scores “may be hardworking, responsible people who regularly pay their bills on time” and could be deemed creditworthy if scored using their “full financial record.” Such records could include history of paying monthly rent, utilities, cell phone bills, as well as their regular management of deposit account cash balances.
Rather than considering members’ strict credit history, which is recorded in traditional credit reports, alternative data displays the bigger picture of what’s going on currently in an individual’s financial life. It can also provide insight into job stability, income, and the member’s daily relationship and interactions with the credit union — all relevant info that is proven to be predictive of future account management and performance for nearly all consumers.
In 2021, a report by the U.S. Government Accountability Office (GAO) focused on mortgage lending cited a study that employed consumer utility and telecommunications payment data. The report discovered the added use of utility data reduced the percentage of unscoreable consumers from about 65 percent to four percent. Even more, the added use of telecommunications data reduced the percentage from 68 percent to less than one percent.
The report expands to suggest certain kinds of alternative data can also help predict default or delinquency for all levels of consumers. For example, it discusses how adding cash flow info such as bank transaction data improved the ability of models to predict the default risk among borrowers across all credit scores.
The traditional system of credit evaluation and reporting works fine for members and consumers with established credit histories, but it unfairly penalizes the possibilities of financial inclusion for individuals who don’t use credit or can’t get approved in the mainstream. While alternative data can’t immediately create equality, it can lessen the financial inequities and improve the accuracy of underwriting.