Alternative credit scores let lenders assess every applicant from multiple perspectives. Lenders no longer have to rely solely on traditional credit scores from the three major bureaus. Advances in loan origination software (LOS) have made it possible for more companies to assess creditworthiness with incredible accuracy.
The best LOS systems calculate alternative credit scores for each loan type offered. To start collecting alternative credit data on your own applicants, you’ll need to work with an LOS vendor that understands the importance of alternative credit data and has experience building reliable scoring systems.
The Power of Alternative Credit Scores
Alternative credit scores are calculated based on data that isn’t typically tracked by one of the three major credit bureaus, such as income and payments for utilities, rent, or even subscription services. It also takes into account non-financial details like driving records and employment history.
How important are alternative credit scores in today’s lending market? They are absolutely essential for three reasons:
- Loans Based on Alternative Credit Scores Are Less Risky
The reason lenders should always supplement traditional scores with alternative credit data is because it reduces risk. Loan applicants who can prove they make monthly payments on time are less likely to be delinquent than applicants who struggle to pay the rent.
Alternative credit data like driving history is also an important factor for structuring car loans. If a borrower wrecks a car before the loan period has ended, it may affect the collateral agreement or cause the borrower to fall behind on payments. An applicant who drives safely is less likely to get into an accident compared to one with a history of speeding tickets or other moving violations. You can’t find that information with a traditional hard credit inquiry.
- Lenders Can Use Alternative Credit Data to Improve Decisioning
Alternative credit scoring is the only way to fairly evaluate your subprime and near-prime applicants. Traditional credit scores are sufficient for assessing applicants who have very high scores (super prime) or abysmal scores (deep subprime). For these types of applicants, alternative credit data provides more detail than you probably need to make a decision. But for applicants who fall somewhere in the middle—the vast majority of applicants—traditional scores aren’t enough.
Let’s say an applicant has a fairly low traditional credit score and falls under the subprime category. On paper, a lender may avoid offering a loan to this applicant due to the high risk associated with subprime lending. However, if the lender looks at the applicant’s alternative credit data and sees that the applicant has multiple recurring bills that he or she always pays on time, the risk level changes. You’re no longer dealing with a subprime applicant. You’re dealing with a near-prime applicant who may just have one ding on their credit report, but who otherwise pays bills on time and doesn’t have any debt. This will affect the loan structure.
- Lenders Can Provide Loans to Those with Limited Credit Histories
Alternative credit scoring is a great way of assessing people who don’t own credit cards. College students may need to take out a personal or auto loan. Without an extensive credit history,traditional credit scores won’t reflect their creditworthiness accurately. By collecting alternative credit data, every applicant is assessed on an individual level and given a fair loan structure.
While there are many benefits to using alternative credit scores, they aren’t easy to calculate. It can be complicated and time-consuming. You have two options: 1) Use the alternative credit score systems that some of the major credit bureaus offer; or 2) Create your own scoring system with help from an experienced LOS vendor.
What Are the Best Alternative Credit Score Companies?
More companies are seeing the value in alternative credit scores and changing the way they do business.
- Experian will soon add utility and cell phone bills to its credit reports;
- TransUnion will collect more alternative credit data;
- FICO has a new system for reporting utility and phone bills, and bank account information; and
- VantageScore is refining a system to track data over a two-year period, in a bid to improve score accuracy.
We’re still in the early stages of the alternative credit score movement. One thing that has prevented the credit bureaus from fully embracing alternative credit data is the need for data security. Alternative credit data is sensitive, requiring extra steps to keep it secure. This problem won’t prevent alternative credit scores from gaining traction, but it has slowed adoption.
Another downside of waiting on credit bureaus and other companies to offer alternative credit scores is that the current options are fairly limited. Lenders can soon add phone bills and utilities to their applicant scoring systems, but this is only one small piece of the picture. They may miss other insights that aren’t currently being tracked by the major bureaus, such as:
- Driving history;
- Real estate information;
- Full rental records;
- Employment history;
- Income over time; and more.
Instead, lenders should consider using a custom LOS system that tracks detailed alternative credit data.
How Your Company Can Leverage Alternative Credit Scoring
Some modern lending systems come pre-integrated with alternative data sources and will automatically take these into account for every applicant. The systems are designed to keep even the most sensitive information safe.
The best modern LOS identify data patterns to discover new trends and connections. An analysis of historical loans may show that consistent employment among applicants correlates with fewer delinquent payments. In response, you can configure the LOS to weigh this bit of alternative credit data more heavily during the decision process from the very beginning.
With alternative credit data fully integrated into a streamlined and modern LOS system, you’ll gain a new perspective on all of your applicants and dramatically improve portfolio performance.
defi SOLUTIONS is a leader in alternative credit data analysis. Our loan origination software collects and analyzes many types of alternative credit data to help underwriters make better decisions. We’ll help you refine your loan structuring process and significantly reduce risk across the board. To get started, contact our team today or register for a FREE demo.
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