Borrowing

Do We Really Need Another Credit Score? Maybe.

By March 14, 2013
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Are you suffering from a case of credit score fatigue? If so, you’re not alone: We hear about credit scores nonstop. We’re supposed to check them regularly. We can order them free online. We can pay someone to monitor them for us. It’s practically a full-time job keeping up with the whole production. And now there’s another score out there we’re supposed to care about?

The thing is, it might be worth paying attention.

The big three credit bureaus — Equifax, Experian, and TransUnion — have just rolled out a new version of their VantageScore (launched as a competitor to FICO, the best-known scoring company) that they say gives banks a better idea of how previously “unscorable” people — between 27 and 30 million Americans — will behave as borrowers.

This is important because under the conventional scoring system, many young people; recent immigrants; those who have declared bankruptcy; and the millions of “unbanked” Americans either don’t have any credit history at all or only show credit activity that took place years before, which counts against them under existing scoring models. Without a recent credit history, these people are generally unable to get credit cards, a mortgage, or an auto or business loan. If they are able to borrow money at all, it’s at a very high interest rate. Insurance companies, landlords, and employers are increasingly checking credit scores, too.

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What’s particularly frustrating for many of these people is the absurdity of their situation: You can’t establish a credit history without access to credit, but you can’t get access to credit without a credit history. The new scoring formula begins to address this issue pulling information from new data sources: For people who don’t have credit cards, car payments or mortgages, information about rent, utility, and cell phone payments can help fill in the gap.

“It’s highly predictive data,” says Barrett Burns, president and CEO of VantageScore Solutions, of these new data sources. Since rent often makes up more than half of the renter’s monthly expenses, whether or not they pay it on time goes a long way towards evaluating their financial stability. Burns says this data point is “incredibly important” for renters underrepresented by conventional credit-scoring metrics.

(MORE: Could Being Racist Make It Harder to Get a Loan?)

Steve Wagner, president of U.S. credit bureau operations for Experian, says a growing number of utilities and cell phone carriers are providing data about payments. “There’s a lot of positive data out there that can be brought in,” he says. Even many people who don’t have bank accounts or credit cards still have cell phones. A record of timely payments to their cell phone carrier would demonstrate that they’re responsible about paying bills.

The new scoring formula also makes it somewhat easier for people to rehabilitate their credit history over time. It doesn’t penalize consumers for collection accounts that borrowers have paid off, for example. Under conventional scoring, collections remain a black mark for seven years, even if the debtor has paid them off. This could help people who lost their jobs and their financial footing when the recession hit and the real estate market went bust.

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A number of upstart tech companies are exploring ways to use all sorts of information, like how connected you are on social networks, to determine the creditworthiness of people who are outside the financial mainstream and don’t show up on the radar of traditional scoring models. For instance, an online payday lender called LendUp looks at the strength of people’s social networks on Facebook (with their permission), on the grounds that a stronger social network correlates to lower risk. A company called Neo that evaluates car-loan applicants does something similar. It evaluates the LinkedIn profiles of applicants (again, with their permission) to see if they have a large number of connections and recommendations, which its underwriting formula correlates with lower risk.

Steve Wagner, president of U.S. credit bureau operations for Experian, says the new VantageScore is different from the big-data and social media risk-prediction models in that it uses more conventional credit scoring information, like what kinds of debts you owe and whether or not you pay your bills on time.

All of this is promising, but none of these advances matter unless lenders actually use the new score. VantageScore says four of the top five mortgage lenders and six of the top 10 credit-card issuers use its score in at least some capacity, but won’t say how widely it’s used across the lending industry as a whole. It’s safe to assume that it’s much less than top competitor FICO, though. Craig Focardi, senior research director of retail banking cards at research and consulting firm CEB TowerGroup, estimates that VantageScore makes up less than 10% of the credit scoring market.

(MORE: Think You Just Bought Your “Real” Credit Score? Think Again)

Still, the score has the potential to offer a lifeline to the millions of Americans who have been marginalized by more conventional credit scoring methods.