It could become easier for some personal-loan applicants to secure a loan after federal regulators announced this week that they encourage the use of “alternative data” in credit underwriting standards — so long as it’s done responsibly.
The Federal Reserve and four other agencies said certain information, like cash flow data, could broaden access to credit.
“To the extent firms are using or contemplating using alternative data, the agencies encourage responsible use of such data,” said the joint statement comes from the Fed, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the National Credit Union Administration.
“The agencies recognize that use of alternative data may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system,” they said.
“Using alternative data may enable consumers to obtain additional products and/or more favorable pricing/terms based on enhanced assessments of repayment capacity,” they added. “These innovations reflect the continuing evolution of automated underwriting and credit-score modeling, offering the potential to lower the cost of credit and increase access to credit.”
The agencies’ statement comes as alternative data — which can range from cellphone bills to utility payments, rent payments and educational attainment — is already being used by some banks and online lenders to evaluate applicants.
Payments on credit cards, mortgages, student loans and auto loans are some of the conventional data points that lenders can track in a credit file when deciding whether to extend a loan, and on what interest terms.
But some would-be applicants might not have that sort of history on their credit file, which could make lenders more wary about extending a loan. An estimated 45 million consumers are “credit invisible” because they don’t have credit records that can be scored, the CFPB says.
“Alternative data” can flesh out the picture of an applicant’s financial health but consumer advocates worry that some of the data can be prone to misuse. For example, utility payments could spike higher after a heat wave or a cold snap and that could result in big bills, late payments and derogatory information on a file.
Tuesday’s joint statement didn’t focus on all types of alternative data, but said data on cash flow could hold promise.
“Improving the measurement of income and expenses through cash-flow evaluation may be particularly beneficial for consumers who demonstrate reliable income patterns over time from a variety of sources rather than a single job,” the statement said.
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That sort of analysis of steady money in and out, regardless of one’s job title, could be especially handy for workers finding steady money in the gig economy.
The statement said alternative data could also be useful in “second look” programs where lenders took another look at consumers who have been previously denied credit.
Chi Chi Wu, a staff attorney with the National Consumer Law Center, a organization advocating for strong consumer protections, said that on the whole, the statement was encouraging and could nudge more people out of credit invisibility.
“Alternative data itself can be good or it can be bad,” she said. The statement’s tone “measured,” Wu said, adding that cash flow was “probably one of the more promising types of alternative data.”
“This kind of statement obviously does matter because it does say be careful, but it could be useful,” Wu said.