Alternative credit scores let lenders assess every applicant from a different perspective. Lenders no longer have to rely solely on traditional credit scores from the three major bureaus. Advances in software platforms that support loan origination processes have made it possible for more companies to accurately assess creditworthiness.
The best loan origination system (LOS) for a lender will calculate alternative credit scores for each loan type offered. To start collecting alternative credit data on their applicants, lenders should seek out an experienced LOS vendor that understands the importance of utilizing software that offers reliable alternative credit data.
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 monthly payments for utilities, rent, or even subscription services. It also takes into account non-financial details like driving records and employment history. Alternative credit scores are absolutely essential in today’s lending market for three reasons.
#1 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 with good credit scores but struggle to pay their 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 ends, 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. This information can’t be found through a traditional hard credit inquiry.
Alternative Credit Data Can Be Used to Improve Loan Decisions
Alternative credit scoring is the only way lenders can fairly evaluate subprime and near-prime applicants. Traditional credit scores are sufficient for assessing applicants with very high scores (super prime) or abysmal scores (deep subprime). For these types of applicants, alternative credit data usually provides more detail than necessary. But for applicants who fall somewhere in the middle, which are the vast majority of applicants, traditional scores aren’t enough.
For example, an applicant with a relatively low traditional credit score falls under the subprime category. On paper, lenders might avoid offering loans to such applicants due to the higher risk associated with subprime lending. However, if a lender looks at an applicant’s alternative credit data and sees that multiple recurring bills are always paid on time, the risk level changes. Lenders can better understand applicants who may have minor issues on their credit report but who otherwise pay bills on time. With this new understanding of the applicant’s risk profile, lenders can structure loans with better terms for this type of borrower and, over time, have greater potential to win more deals.
Lenders Can Provide Loans to Those With Limited Credit Histories
Alternative credit scoring is also a great way to assess people who don’t carry credit cards. For example, college students may need to take out personal or auto loans, but without an extensive credit history, their credit scores through traditional credit bureaus won’t accurately reflect their creditworthiness. Alternative credit data gives every applicant a chance of a fair assessment, along with a more suitable loan structure.
Alternative credit scores offer lenders many benefits, like further expanding their portfolios with little risk. Yet calculating them is often complicated and time-consuming. As a result, lenders have two options when seeking to utilize alternative credit scores. First, they can use the alternative credit score systems that some major credit bureaus offer. Or create their own scoring system with help from an experienced LOS vendor.
What Are the Best Alternative Credit Score Companies?
An increasing number of companies see the value in alternative credit scores and are changing how they do business, including:
- Experian has added alternative financial servicing, consumer-permissioned data, monthly rental payments, and public records to its credit reports.
- TransUnion is collecting more alternative credit data, including comprehensive court records.
- FICO has a system for reporting utility, cell phone, and other bills, along with bank account information.
- VantageScore is also refining its system to track data over a two-year period in a bid to improve credit score accuracy.
The lending industry is still in the early stages of the alternative credit score movement. However, the need for data security has prevented these credit bureaus from fully embracing alternative credit data. Alternative credit data is sensitive information, requiring extra steps to keep it secure. This won’t prevent alternative credit scores from gaining traction, but it has slowed its adoption.
One major downside is that these current options for alternative credit scores are fairly limited. While these credit bureaus will soon offer phone bills and utilities to their applicant scoring systems, this is only a small piece of the picture. They may miss other insights that major bureaus aren’t currently tracking, such as:
- Driving history
- Real estate information
- Full rental records
- Employment history
- Income over time
- and many others
Instead, lenders should consider a customizable LOS from a reputable third-party vendor that tracks detailed alternative credit data.
How to Leverage Alternative Credit Scoring
Some modern lending systems come pre-integrated, with alternative data sources that are automatically taken into account for each applicant. These systems are also designed to keep even the most sensitive information safe, so they don’t pose a risk to a lender’s future customers.
The best modern LOS will identify patterns in data, allowing lenders to discover new trends and connections. For example, an analysis of historical loans may show that consistent employment among applicants correlates with fewer delinquent payments. In response, lenders can configure their LOS to weigh this bit of alternative credit data more heavily during the decision process.
With alternative credit data fully integrated into a streamlined and modern LOS system, lenders can gain a new perspective on all of their applicants, resulting in dramatically improved portfolio performance.
defi SOLUTIONS offers a total solution for a lender’s complete loan or lease lifecycle. Partnering with captives, banks, credit unions, and finance companies, defi’s market-leading solution helps lenders exceed borrower expectations. From digital engagement through the complete lending process, defi sets new standards for flexibility, configurability, and scalability in originations and servicing (by your experts or ours). defi SOLUTIONS has the backing of Warburg Pincus, Bain Capital Ventures, and Fiserv. For more information on how to effectively use alternative credit score data, please visit www.defisolutions.com.