Key insights:
- Credit bureaus and credit scores play an important role in financial access. But they are outdated due to their narrow lens and limited data.
- This lack of innovation in credit products has substantial impacts on people’s lives and livelihoods.
- A smart use of alternative sources of financial data can address many shortcomings.
- The end result will be a fairer and more inclusive financial system.
Across industries, consumers engage in a wide range of grand bargains pertaining to their personal data. It works like this: In return for giving companies access to information about ourselves, we get some degree of greater convenience, more personalized offerings, and better experiences.
For instance, when we allow cookies to collect our internet browsing and buying history, we get tailored recommendations on shopping sites or customized selections of music and TV shows on streaming platforms. In exchange for letting a smart thermostat gather information about our household’s climate control habits, it can automatically adjust our heating and cooling to save energy and costs. Letting the sensors on digital blood-glucose meters continuously monitor your blood sugar means it will alert you when levels are nearing troubling thresholds. Even something seemingly simple like sharing identification data across platforms like Google rids us of the hassle of daily password retrievals or resets. The list goes on.
But in the financial services industry, the use of data to deliver better experiences or improvements to people’s lives — especially those involving credit — is lagging. Consumers have very limited ways of giving financial companies access to additional data that might lead to them getting a better mortgage rate or bigger loan. Instead, when people apply for credit, such as a mortgage, credit card, car loan, or personal loan, they are beholden to an antiquated system that relies on a narrow band of their data to determine whether someone is creditworthy. This system is governed by three major U.S. credit bureaus (Experian, Equifax, and TransUnion) that look primarily at a consumer’s loan repayment history to generate their FICO credit score.
“Today, millions of Americans are unnecessarily denied access to financial products that could change their lives.”
Unfortunately, this system doesn’t always paint an accurate, complete picture of someone’s creditworthiness. Today, millions of Americans are unnecessarily denied access to financial products that could change their lives. Credit scores and credit reports determine whether someone’s loan gets approved, the amount of the loan, and what the terms will be. They can also affect whether someone gets approved for a lease on a house or apartment. While this system has succeeded in delivering stability to the lending market, it’s due for an overhaul.
Consumer financial data regulations for the digital era
That overhaul is coming. In the future, instead of three centralized credit bureaus that reduce people to a single number, a variety of innovative credit analytics providers could use a wide range of information to better understand a consumer’s financial story (all with a consumer’s permission, of course).
“In return, consumers will be able to get access to better, fairer, more personalized credit options.”
Regulatory changes are helping drive this evolution. The Consumer Financial Protection Bureau’s 1033 Rule, which paves the way for the kind of “open banking” already well established in the EU and UK, will give U.S. consumers the ability to share their bank transaction data with lenders and other financial service providers. In return, consumers will be able to get access to better, fairer, more personalized credit options. The lending industry will also benefit by identifying customers who had been previously screened out. A 2022 Nova Credit survey of 185 lending industry decision-makers found that the majority (74%) believe traditional credit report data does not paint the most complete picture of consumer creditworthiness.
A richer financial profile
So how will access to additional data help create a better, more accurate credit system? To determine whether someone should get approved for a loan, today’s credit bureaus look backward at a person’s previous credit experience, such as how much they have borrowed and their repayment history. But these historical data points don’t necessarily reveal anything about someone’s current ability to repay a loan or afford a certain amount of rent.
Tomorrow’s credit system will not only look at past credit history, but also compose a more complete picture of a consumer’s current finances. This could mean looking at income and employment status, as well as bank account data like transactions and balances.
Since the average tenure of a U.S. consumer’s bank account is roughly 14 years, this information represents a tremendous source of history and insight into a consumer’s financial health. Many people pay their utilities and rent, and receive payroll disbursements, through their bank.
For the past several years, Nova Credit has been using this type of detailed, consumer-permissioned alternative data to build more granular risk profiles. Take the case of a consumer who has a low credit score but has never missed a utility payment, has been in the same job for four years, and recently got a raise. Traditional models wouldn’t have enough data to override their low credit score. Ours would show that this consumer could be suited to a credit line increase. Although fintechs like ours have been accessing alternative data with APIs, the CFPB’s open banking rule, which could take effect later this year, would make alternative data easier to access and more broadly available.
The data-driven credit bureau of the future
As with any significant wave of modernization, the injection of new rules and practices will have wide-ranging impacts and inspire new types of products and services. We see two particularly positive developments:
1. Fewer people who are credit invisible and credit disadvantaged. Some 60 million Americans currently have no credit score and thus experience significant difficulty getting loans. Another 40 million have insufficient credit history to accurately paint a full financial picture. The reality is that many of these people are not high-risk. They have steady jobs, bank accounts, and a record of making payments for rent, utilities, and other obligations; but without access to additional data, credit bureaus can’t properly assess them. Young people also fall into this category. Giving young adults the ability to share financial data that establishes their creditworthiness can provide them with a running start.
Recent immigrants are also credit invisible. Every year, more than 2 million newcomers immigrate to the U.S., but their credit histories don’t migrate with them. Newcomers account for nearly 100% of U.S. population growth, representing a significant missed opportunity. Upon arrival, when immigrants need credit the most, financial institutions have no way of assessing their worthiness. We’ve worked to fill in this gap by not only integrating cash flow data, but building relationships with credit bureaus in more than 20 countries in order to translate international credit reports into local-equivalent credit scores and risk attributes.
“Giving young adults the ability to share financial data that establishes their creditworthiness can provide them with a running start.”
Similarly, not all 41 million Americans with low credit scores (below 579) deserve to be considered high-risk. A disproportionate number of these consumers are Black, Hispanic, and low-income. The ability for lenders to make more accurate decisions and stronger predictions about a consumer’s creditworthiness will contribute to more equitable lending practices.
2. New types of dynamic credit products and financing mechanisms. With access to additional data and more accurate risk profiles, lenders can offer consumers innovative options and greater choice. Currently, most traditional lenders allow consumers minimal choice about the terms of their loan. Interest rates and loan repayment deadlines and durations are fixed. Customizable credit products would allow consumers to choose their own repayment schedule, including pauses when money is tight. Imagine a teacher who wants to pause their car payments over the summer when cash flow is lower or more unpredictable, then pay a slightly higher monthly amount in the fall, while doing bi-weekly payments in spring. Early examples of this customization include buy-now-pay-later companies, which provide shoppers with new options for making purchases, and flexible rent apps that provide credit to renters, allowing them to split their payments into smaller chunks.
Farther down the road, embedded finance could broaden the lending field so that any organization could issue credit. For instance, a company could use their capital to extend loans to their employees or customers. We see the beginnings of this in employers that use their payroll provider to offer employees advances on portions of their paycheck.
We’re just at the beginning. Building the data infrastructure to support all this will take time. But I believe these positive changes are inevitable and well underway. Using additional sources of data to round out consumer financial profiles will help increase affordability and give people more control over their financial lives. It’s a grand bargain many consumers will undoubtedly want to embrace.
