Alternative Data and its Ability to Open Doors to a Brighter Financial Future
The COVID-19 pandemic has impacted American lives in numerous ways, including financial hardship and potential difficulty obtaining credit. According to the Federal Reserve, 19% of adults indicated that they either lost a job or had their hours reduced in March 2020, when shutdowns were initiated. [1] The Fed also found that 18% of adults indicated they did not expect to be able to pay all of their April 2020 bills in full and of those who lost their jobs, 35% anticipated not being able to pay all bills in full.[2] Following the initial shock of the pandemic, between Q1 2020 and Q1 2021, overall wealth increased in the U.S., but it was highly concentrated in top 10% of wealth holders. As the wealth gap increases, the bottom 50% will continue to have a more difficult time obtaining credit via traditional channels, which has spurred continued conversations in Congress and the Biden-Harris Administration around the use of alternative data to provide an avenue for access to credit.[3]
Since the introduction of FICO® Score in 1989, credit scores in America have been a significant driving factor in adults’ financial lives.[4] When calculating a credit score, the nationwide consumer reporting agencies – Equifax, Experian and TransUnion (collectively, “CRAs”) have typically relied on evaluating payment performance on traditional credit channels such as credit cards, mortgages, and other consumer loans.[5]
However, in a typical “chicken and egg” conundrum, many U.S. consumers do not have sufficient credit history to obtain these traditional, prime forms of credit, and without access to credit, they have difficulty building their credit history. According to the Consumer Financial Protection Bureau (“CFPB”), approximately 10% of adults experience “credit invisibility,” where they do not have any credit history reported with the CRAs to generate a credit score.[6] Many people who live outside the traditional credit ecosystem still manage to pay their rent and utility bills, but those non-loan payments typically are not used to calculate traditional credit scores.[7]
Suppression vs. Using Alternative Data
In recent months, House Democrats tried including a provision in their House-passed HEROES Act that would delete adverse data reported to the CRAs during the pandemic.[8] While these proposals are certainly well-intentioned, research has shown that, if passed into law, they could hurt the very same population Congress is intending to help – the underbanked and those in underserved communities.[9] A study conducted by PERC found that consumers in low-income households were most negatively impacted by these proposals, with credit approvals falling 37% for those in the lowest income households.[10] Moreover, the study found that although the credit scores artificially rose, credit approvals declined.[11] If lenders are not able to see a full, accurate picture of a consumer’s borrowing and payment habits, lenders will be hesitant to extend credit to avoid underwriting risk.
Instead of suppressing information, revamping credit reports by including more data such as utility, telecommunications, and rental payments would bring more consumers into the credit ecosystem. Currently, many consumers do not get any credit for making these payments on time, but property managers and utility companies may send unpaid notices to debt collectors, which can seriously impact credit scores. In short, paying rent and bills on time often does not help your credit but delinquent payments can hurt.
There is currently a bipartisan and bicameral bill sponsored by Senator Manchin (D-WV) and Senator Scott (R-SC) that would encourage landlords, telecommunication companies, and utility providers to report on-time, positive-only payments to credit bureaus.[12] Studies have shown that the inclusion of alternative data can significantly raise a consumer’s credit score.[13] TransUnion completed a study which found that when rent payments were included in a credit file, consumers experienced an average increase of nearly 60 points to their credit score, which is a material increase and could open the doors to financial inclusion.[14]
Providing Alternative Data Responsibly
Introducing additional consumers into the credit ecosystem through alternative data will potentially broaden the customer base for traditional lenders as well as entities such as landlords and telecommunication companies. However, these entities that choose to participate in supplying alternative data should also be aware of compliance requirements to avoid potential pitfalls from regulators. For example, under the Fair Credit Reporting Act (“FCRA”), data furnishers have an obligation to provide accurate information about consumers and to perform a reasonable investigation on credit disputes received directly from consumers and indirectly through the CRAs.[15] These disputes should also be responded to within the statutory timeframes per the FCRA, which is generally 30 days after receipt.[16]
New data furnishers should understand the specific required components for FCRA-related policies and procedures under Section III of Appendix E to Part 1022 – Interagency Guidelines Concerning the Accuracy and Integrity of Information Furnished to Consumer Reporting Agencies (“Appendix E”). This Section lists 13 separate components that should be addressed, including using standard data formats, record retention, deletion of records and conducting a periodic evaluation of a company’s own practices.[17]
Another important component of Appendix E is performing quality control on the data that is sent to the CRAs. The CFPB in particular has made it clear through previous enforcement actions that there is an expectation that furnishers will perform self-audits and monitoring to ensure the accuracy and integrity of data transmitted to CRAs.[18]
It is highly recommended to take a sample of accounts (also known as tradelines) and recalculate what the tradeline should have been reported for that month. This sample is then compared to what was actually furnished and any differences can be investigated to determine the root cause. If the root cause is a potential system, technology, or process issue that could lead to other accounts being impacted, those issues should be prioritized and resolved accordingly. If it is a one-off item, such as a manual processing error, this can be addressed through training and potentially the development of other controls.
Finally, since there are constant changes that impact credit reporting, it is important for institutions to develop processes to operationalize these changes, including updates to policies and procedures, technology, staffing, and training. One recent example is the regulatory changes due to CARES Act requirements, which prohibited reporting negative information due to pandemic-related accommodations.[19] Other requirements may be updated annually, such as those to the Credit Reporting Resource Guide published by the CRA industry group.[20] New data furnishers should engage early and often with their key internal stakeholders to understand and preemptively assess any downstream impact to credit reporting from these changes.
The pandemic has exacerbated and highlighted the inequalities among Americans when it comes to financial inclusion. If regulators and lawmakers can take action to bring more consumers into the credit ecosystem, it could make a significant positive impact on financial opportunities for many Americans who are most in need of them. Both furnishers and credit reporting agencies should communicate the importance of alternative data and work with the policy community as well as third parties to better shape the narrative around the appropriate use of alternative data in the underwriting process and how this type of data can bring more people into the credit ecosystem. Those institutions that choose to furnish alternative sources of consumer data should be aware of compliance requirements so they can report data responsibly.
References
[1] “Report on the Economic Well-Being of U.S. Households in 2019, Featuring Supplemental Data from April 2020,” at 4, Board of Governors of the Federal Reserve System (May 2020), https://www.federalreserve.gov/publications/files/2019-report-economic-well-being-us-households-202005.pdf.
[2] Ibid.
[3] Michael Batty, Ella Deeken, and Alice Henriques Volz, “Wealth Inequality and COVID-19: Evidence from the Distributional Financial Accounts,” Board of Governors of the Federal Reserve System (August 30, 2021), https://www.federalreserve.gov/econres/notes/feds-notes/wealth-inequality-and-covid-19-evidence-from-the-distributional-financial-accounts-20210830.htm.
[4] FICO.com Home Page (accessed February 1, 2022), https://www.fico.com/25years/.
[5] “What is Payment History?” MyFICO.com (accessed February 1, 2022), https://www.myfico.com/credit-education/credit-scores/payment-history.
[6] Liane Fiano, “3 common credit issues and what you can do to fix them,” Consumer Financial Protection Bureau (April 13, 2018), https://www.consumerfinance.gov/about-us/blog/3-common-credit-issues-and-what-you-can-do-fix-them/.
[7] “How to report your rent payments to credit bureaus,” Bankrate.com (accessed February 1, 2022), https://www.bankrate.com/finance/credit-cards/how-to-report-rent-payments-to-credit-bureaus/.
[8] The Heroes Act, H.R. 6800, 116th Congress (2020), https://www.congress.gov/bill/116th-congress/house-bill/6800/text.
[9] Michael A. Turner, Ph.D., Patrick Walker, M.A., and Kazumi Moore, “Addition is Better than Subtraction: The Risks from Data Suppression and Benefits of Adding More Positive Data in Credit Reporting,” PERC (June 2020), https://www.perc.net/wp-content/uploads/2020/06/credit-data-suppression-deletion-addition.pdf.
[10] Ibid.
[11] Ibid.
[12] Credit Access and Inclusion Act of 2021, S. 2417, 117th Congress (2021), https://www.congress.gov/bill/117th-congress/senate-bill/2417/text?r=63&s=1.
[13] Michael Turner and Patrick Walker, “Potential Impacts of Credit Reporting Public Housing Rental Payment Data,” U.S. Department of Housing and Urban Development – Office of Policy Development and Research (October 2019), https://www.huduser.gov/portal/sites/default/files/pdf/Potential-Impacts-of-Credit-Reporting.pdf.
[14] “Alternative Data Such as Rent Payment Reporting Bridges the Gap for Unscorable Consumers and Increases Financial Inclusion Opportunities,” TransUnion LLC (July 15, 2021), https://newsroom.transunion.com/alternative-data-such-as-rent-payment-reporting-bridges-the-gap-for-unscorable-consumers-and-increases-financial-inclusion-opportunities/.
[15] Fair Credit Reporting Act, 15 U.S.C. § 1681, § 1681s–2 (1970).
[16] Ibid.
[17] 12 C.F.R. Appendix E to Part 1022 (2012).
[18] “Enforcement actions,” Consumer Financial Protection Bureau (accessed February 1, 2022), https://www.consumerfinance.gov/enforcement/actions/?title=data&from_date=&to_date= (search “data” in the “Search by keyword(s)” dialogue box under the heading “Filter enforcement actions”).
[19] Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law No. 116-136 (2020).
[20] CDIA Publications (accessed February 1, 2022), https://www.cdiaonline.org/publications/.
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