Credit scoring agency FICO just announced that it will soon start offering lenders a new rating system to assess borrowers who don't have enough credit history to qualify for loans and credit cards. The new ranking system is called FICO Score XD, and it bases borrowers' scores on phone, internet, cable and utility payment history as well as other public records.
FICO started the project as a pilot program last year, and participating lenders reported that up to 50% of credit applicants had scores of 620 and up, which qualified them for most entry-level credit cards and small loans.
There's a growing market for alternative credit scoring techniques. FICO's new moves come after TransUnion recently unveiled its own alternative rating system called CreditVision.
FICO's Score XD and TransUnion's CreditVision use data like tax, property and deed records, checking and savings account history and reports from payday lenders to calculate scores for potential borrowers without much in the way of credit history.
Peer-to-peer lending sites like Lending Club and SoFi already use proprietary methods to rank borrowers that take into consideration a lot more information than a simple FICO score, and that's a good thing.
According to a recent report by the Consumer Financial Protection Bureau, 45 million Americans, or about 1 in 6 of us, don't have enough credit history for ratings agencies like FICO, TransUnion and Experian to calculate an accurate score.
The CFPB report divides those 45 million Americans into 2 groups: the 26 million so-called invisibles, who don't have any credit history, and the 19 million unscorables, whose credit histories are too short or too outdated to receive scores from the major ratings agencies.
Race is a major factor that determines access to credit, according to the CFPB. About 28% of blacks and Hispanics are either credit invisible or unscorable, compared to only 16% of Asians and whites.
Using alternative methods to rank potential borrowers could mean that tens of millions of Americans get access to the credit they need to start businesses and buy cars and houses.
Of course, there's also a downside to the new credit scoring methods. As if a pull of credit history were not intrusive enough, peer-to-peer lending start-ups and now major credit ratings agencies will check Facebook, LinkedIn and other social media profiles and use magic algorithms to decide whether borrowers are creditworthy.
For the credit invisibles and unscorables, Facebook friends could matter as much as a history of paying or not paying debts in the near future.
TransUnion's CreditVision page sells itself to potential lenders with the argument that only institutions with a complete view of the consumer will survive the modern, dynamic and unpredictable economy.
Except that complete view means that many consumers and would-be borrowers will have to sacrifice a good part of their privacy in order to qualify for what many of us take for granted: access to credit cards and loans at reasonable terms.
Companies need to protect their bottom line while expanding their customer base, and new tools like FICO's Score XD and TransUnion's CreditVision will help them do that. But the trade-off is that credit invisibles and unscorables will have to allow ratings agencies a very close peek at their personal lives.