Most Americans need credit to buy a house or car, and to get credit, they need a credit score. Credit scores rely on past payment information to gauge a borrower’s risk. But that reliance on credit history presents a paradox. Some Americans can’t take advantage of lines of credit — either because the information for them on file is insufficient or because they have no credit record at all.
Help finding a way in for those currently shut out of the credit system presents a huge opportunity — not only for credit-starved individuals, but also for lenders looking to tap a new customer base.
Fair Isaac, the company better known for its trademark FICO credit scores, is set to unveil a new scoring method for those without much of a credit history that uses alternative financial data like utility, cable and cellphone bills and rental history. (Traditional FICO credit scores are based on reports from the three major credit bureaus.)
FICO says that as many as 53 million Americans don’t have a traditional score, citing their own records. The company has scored about 15 million of those people using its new method and claims that one-third of them, or 5 million people, would have an equivalent FICO score above 620.
Scores that high would allow those 5 million people to get a mortgage, car loan or credit card they couldn’t get otherwise. And they could help some consumers avoid the high interest charges of predatory lenders.
But the devil is in the new algorithm’s details. FICO says that roughly 28 million of the 53 million currently credit-scoreless Americans are people with scant information in their credit records; the other 25 million are those without any credit record whatsoever.
We don’t know which group FICO is scoring. It could be both or mostly those with a credit file but little information. But if it’s mostly those who lack any credit history, it’s hard to believe many of them would have high credit scores.
That’s because FICO bases its estimates of the number of unscored individuals on the fraction of American adults who are “unbanked” — those without a checking or savings account — according to a report from the Political and Economic Research Council, a think tank that supports the use of alternative data in credit scoring. And about 85 percent of the unbanked have a household income below the national median, meaning they likely have low credit scores if they have them at all.
So the success of FICO’s new method hinges on how accurately it can assess the risk profile of people who don’t have any credit history. If they are dramatically different from the general population, then the new scores could lead to an influx of credit to risky borrowers. But if appropriately calibrated, they will give credit where credit is due.