Credit Basics
Boon or Bust?
A new credit-scoring system could help millions of Americans-or will it just encourage them to take on more debt?
Wednesday, August 25, 2004
Jennifer Barrett
Newsweek
He's got plenty of company. At least 50 million Americans lack the credit to get credit. Without the conventional history to establish the credit score used by lenders to determine an applicant's ability to repay a loan, it's tough-and, in some cases, nearly impossible-for some consumers to obtain a mortgage or credit card. Now Dillon is trying to make the process easier. As vice president of global scoring solutions at Fair Isaac Corp., the company behind the credit scores lenders use to judge applicants, he's developing a new, extended scoring system that uses information from non-traditional sources. By taking into account data like consumers' monthly rent payments, utility bills, and rent-to-own retail accounts-which are not normally reported to credit bureaus-Fair Isaac hopes to expand the credit files of millions of divorcees, immigrants, recent college graduates, and others who don't have a traditional credit history. "There's a fragment of population that is not reported and it's difficult for them to break in. We're trying to address this unequal access," says Dillon. "I definitely would have benefited from this if it had been around five years ago."
Creditors have become more dependent on a consumer's FICO score as the application process has become increasingly automated, with many people applying for loans and credit cards over the phone or Internet. Fair Isaac's computerized model, which generates a score between 300 to 900, is now based on payment and balance data submitted by banks, credit card companies, and mortgage lenders. The higher the applicant's score, the lower the repayment risk and, hence, the lower the interest rates. But an estimated 5 to 15 percent of all loan applications are not even processed now because there is not enough credit information about the applicant to compute a score.
"Generally speaking, without traditional credit scores many lenders simply can't facilitate a transaction, whether it's a credit card, a loan or a mortgage," says Dan Drummond, spokesman for Your Credit Card Companies, a consortium of financial-services firms. "We think this will open up access to credit at reasonable interest rates for people who probably already should be qualifying for it already. It could make a huge difference."
According to Fair Isaac estimates, about 20 million Americans have no credit information on file at all and the remaining 30 million or more don't have enough information on file to create a traditional credit score. How much the expanded scoring system will help them, though, is still up for debate. "Depending on what kind of information they are going to use, it could be a boon for consumers who previously had no credit history or it will be major bust, opening them up to targeted marketing by a whole range of sleazy creditors," says Travis Plunkett, legislative director for the Consumer Federation of America. "The devil really is in the details."
Fair Isaacs says the data will be generated through consumer reporting agencies that track particular industries like payday loans, or through evidence produced by the consumers themselves like cancelled rent checks or utility bills. For the latter, lenders could validate the payment information and submit it to Fair Isaac and it would be incorporated into the applicant's credit rating.
But consumer advocates worry that some of these non-conventional sources are looked upon negatively by mainstream financial lenders, regardless of an applicant's steady payment history. Payday loans, for example, are small, short-term loans given to consumers who use their next paycheck to pay it back. The borrower writes a personal check for the amount and the lender agrees not to cash a check until the next pay day. But the borrower often pays a large fee for such a service, as it is considered a high-risk loan. Those who seek mortgages from alternative mortgage provider may also be regarded badly, as financial institutions may assume they have been turned down by traditional banks. "The assumption that some credit history is better than none may be incorrect. We know for a fact that there are some particular items seen negatively by mainstream financial institutions," says Plunkett. "Will this relegate them to the sub-prime ghetto?"
Dillon insists that the new scoring system is not intended to expand the market for sub-prime financial products, which are aimed at riskier populations and come with high interest rates. "Our goal is to identify the people who can manage an auto loan or a credit card," he says.
In the beginning, at least, consumers for the most part will originate the process when they apply for a mortgage or credit card, for example, and the lender informs them of the additional data they can use to demonstrate their credit history. If they proceed, Fair Isaac would then help to establish their credit ratings using the non-traditional sources. Dillon says the company is not currently compiling data for creditors' pre-screening purposes so consumers need not be worried about getting inundated with a sudden flurry of "pre-approved" credit card offers-for now anyway.
But credit counselors worry that those who do apply and qualify for low-interest credit cards or loans under the expanded credit scoring may have trouble paying them off. Just because someone has paid their rent and utility bills on time does not mean they can afford to take on additional credit card payments, they say. "Consumers think, they wouldn't have given me the credit line if they didn't think I could afford to pay it back," says April Lewis-Parks, spokesperson for Consolidated Credit Counseling Services, one of the nation's largest non-profit credit counseling agencies. Many Americans are already struggling under their credit card debt, and personal bankruptcy filings have reached all-time highs, according to U.S. courts. A record 1.625 million people filed for personal bankruptcy in the 2003 fiscal year. "To use this for an unsecured credit card might not be good because they would still have to pay their rent and utilities plus they're taking on additional debt," says Lewis-Parks.
She estimates about 25 percent of those who do not have credit scores now might fall into this category. It will be up to the new scoring system to determine who they are. "It all depends on what's going to go into this score and what won't, and how it is interpreted," says Plunkett.
And it could be several months before that's clear. The extended scoring has just been introduced and, at this point, while many lending institutions have been informed, few of the 50 million consumers who could benefit will likely be aware that it exists-until they apply for a loan.
