Since the 2008 financial crisis, a growing number of consumers have questioned the current credit scoring system that runs our financial lives. Even consumers with good financial habits find it difficult to access the credit they desire because of their "thin" credit files.
"Millions cannot access money at fair rates," says Juan Tavares, the co-founder of loan site LendingPoint. "As it relates to determining creditworthiness, traditional credit scores are based on incomplete information, and regulation has shackled traditional lenders in the way they have defined acceptable risk limits for banks."
The current climate makes it difficult for many consumers to "prove" that they should be approved for loans, even if their financial habits are practically perfect. Steve Stewart, the founder of MoneyPlan SOS, has long been an advocate of credit-free living. He suggests that you can get by on debit, and save up for car purchases.
But what happens when you're ready to buy a home? Even Stewart knows that most people aren't going to be able to save for mortgage. How can you qualify for a mortgage when you haven't built a strong credit history?
Tavares and Stewart both think that changes are coming to the credit scoring landscape, and that consumers can make a big difference in how quickly this transformation takes place.
Credit Decisions Based on More -- and Better -- Data
Most consumers are familiar with the ideas behind credit reports and credit scores. However, many think the emphasis on credit in the current credit scoring system is unfair. Even though it's a credit score, the reality is that there are other consumer behaviors that indicate overall financial reliability just as well as borrowing money and repaying debt.
Besides, many consumers and advocates point to the fact that credit scores aren't just used for qualifying you for credit and helping you get the best loan rate. Your credit profile might be used for decisions about a rental or qualify you for cell phone service. In some states, insurance companies are allowed to use your credit score when deciding on your auto insurance premium. If all of these non-credit decisions are being made using data from your credit report, shouldn't the credit scoring industry expand its criteria to include non-credit financial habits?
"Consumers are getting the short end of the stick because traditional lenders lack the appetite and new lenders lack the experience to use the tools available to them to establish creditworthiness beyond traditional models," Tavares says.
Rather than rely entirely on traditional scoring models Tavares thinks that lenders -- and the credit industry as a whole -- should embrace better data. He says that there are new direct lenders willing to use broader models that consider information about non-credit accounts, including rental payments and other activities that indicate financial responsibility, without relying on a consumer's interaction with debt.
"Better indicators are created by making meaningful connections between traditional and nontraditional data," Tavares says. "Credit scores are only a part of the story. Nontraditional data allows us to look at trends in consumer behavior that complete the picture."
This is the type of data that progressive lenders use to make decisions about lending money. Consumers who might otherwise have insufficient credit data can qualify for loans when other factors beyond what constitutes traditional credit scoring are used.
Stewart is also interested in changes broadening the type of data used to make lending decisions. He knows that creditworthiness is important -- especially if you want to buy a home someday -- but he doesn't think you have to play the traditional credit scoring game. He recommends using an alternative credit scoring company like eCredable to establish a good financial reputation. With alternative credit scoring models, the type of information used to build your reputation is in your hands. It's possible to build a credit profile with non-credit payment information, such as your rent, utilities, insurance, layaway and gym membership.
All of this is regular payment information (except for rent, which might figure in some credit scoring models now) wouldn't normally be included in a traditional credit decision. However, if you have an alternative credit report, lenders are required by law to consider the report. This gives the consumer a little more power.
How You Can Change the Credit Scoring Landscape
There is already evidence that consumers are starting to push back -- and you can help.
You can refuse to participate in the credit culture (aside from a home loan) and use alternative credit bureaus to build a profile that includes non-credit trade lines. If more consumers take these reports to their lenders, and enough fuss is raised about it, more credit reporting agencies will expand their outlook. In fact, the concessions that some credit reporting agencies have already made for rent payments mark a consumer victory of sorts.
If you want to use credit, you can borrow from lenders that use alternative data. Reward those who are willing to think outside the box. "Consumers can fight back and reclaim financial decision-making power by finding programs and lenders that help them graduate to better offers," says Tavares. "You have to break the cycles of debt and repayment, and find ways to build momentum."