Assessing credit risk is an imperfect science. Undoubtedly, some creditworthy consumers are denied because their credit score underestimates them, while others land offers because their score overestimates their standing—and might reflect higher risk if their full financial picture came into view.
A Consumer Financial Protection Bureau (CFPB) study found 26 million U.S. adults fall outside the purview of traditional credit bureau scores and were considered “credit invisible.” This essentially punishes those who fail to provide credit history because they lack credit cards. Research also indicates that many of these “underbanked” consumers are either millennials, who will represent one-third of the adult population by 2020, or U.S. immigrants. The report also found that African-American and Hispanic consumers, and/or those in low-income neighborhoods, are more likely to have no credit history with a nationwide consumer reporting agency, or not enough credit history to produce a credit score.
Over the past decade “alternative credit scores”—based on data traditional U.S. scores do not consider—have gained strong adoption as a means to address this gap. Run at the same time as traditional credit scores, they help lenders gain more insight into credit worthiness and whether to extend consumer loan access.
In October 2018 Experian, FICO and Finicity announced a new spin on alternative credit scores, the UltraFICO Score, that takes a different approach to assessing credit invisible and near-prime consumers. It allows them to incorporate banking information into the traditional FICO model and by opting into UltraFICO, eligible consumers can share their checking, savings and/or money market account history. In theory, this provides a more complete picture of their financial situation.
It’s generally agreed that broadening access to credit is positive for the consumer, lender and overall economy. But a number of reasons exist to view the true impact of UltraFICO scores with skepticism.
Should you share data for a fair share of credit?
The primary use case for UltraFICO occurs when a consumer requests a reevaluation after being declined for credit or offered a lower credit line than they applied to receive. Essentially, the new score could offer some consumers a second chance. By opting into UltraFICO and providing additional bank account data, individuals could reapply to improve their scores and get approved.
Yet the notion that consumers would directly provide lenders with access to their banking data—new to the credit-scoring market—raises major questions as to how this will work in practice.
Most alternative credit scores work in tandem with traditional ones at the time of application to facilitate a more informed approval and pricing decision. But the default UltraFICO use case targets consumers already evaluated and declined for their desired product and pricing. If you’re a consumer who gets turned down by a lender, would you opt to share sensitive banking data with the company that just rejected you? Relying on consumers to do this, especially in the wake of a negative experience, is an unproven practice at best. Will they embrace the concept?
Can lenders rely on UltraFICO scores?
By offering consumers the option to share bank account information, UltraFICO gives people more control over telling their own financial story. That’s why FICO brands it as the “consumer-powered score.”
But this could represent a double-edged sword for lenders when it comes to accuracy. With UltraFICO, consumers can pick the bank account information they share—which means they don’t have to disclose everything.
Thus the conundrum is simple: What if consumers only provide the positive side of their financial story and hide the negative parts?
Suppose someone holds several accounts with different banks. With bank number one, they might maintain a stable checking account that shows a modest amount of money and recent deposit increases from a well-paying but short-term job. And with bank number two, that same person might hold an old savings account that shows no growth because the money constantly gets deposited and withdrawn, along with a checking account pinged by regular overdrafts.
With UltraFICO, this individual could share the positive account information from bank number one while not disclosing the account history of number two. This deceptive behavior could put lenders at risk as they issue credit to consumers. Or it could mean that lenders won’t put much stock in the score’s assessment.
Lenders must also consider the experience they create by underwriting consumers based only on traditional credit scores, then offering declined consumers a chance to share more data for another evaluation. Many alternative credit scores currently on the market can inform the original underwriting decision; several use the same kind of consumer banking data UltraFICO requires. So will banks want to put applicants through this experience when they have the ability to get the assessment right the first time?
How will banks and other lenders respond?
Expanding consumer access to credit represents that rare mandate where consumers, lenders and regulators all agree. There’s a broad understanding that traditional credit scores aren’t perfect—and that pulling alternative data into assessments could bring stability and opportunity to consumers, and revenue to lenders. The new question UltraFICO brings to the table is: What’s the best way to work these insights into lending decisions?
It’s unlikely we’ll know anytime soon—given the lengthy process of evaluating credit tools, UltraFICO’s limited distribution (only Experian offers it), and the unknowns around how consumers and lenders will embrace its user experience.
For now, we can only say that UltraFICO represents a new kind of credit tool in a risk manager’s toolbox—and proves that the strategy of leveraging alternative data to improve lending decisions is here to stay. In the meantime, we’ll have to wait for more data before this tool gets the credit it may well deserve.
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Kevin King is director, product marketing at ID Analytics.
