New findings by consumer risk management firm ID Analytics found that 35% of new credit card applications are made by millennials. That’s 6 points higher than the applications submitted by Generation X, and 7 points higher than baby boomers. While the demand for credit cards among this age group appears to be higher than most, the approval rates are less than impressive. One in five people between the ages of 23 and 27 have been declined for credit multiple times within a single year. Once declined, an overwhelming majority does not re-apply for at least a year.
The biggest obstacle facing millennials in their struggle for new cards appears to be their credit scores. ID Analytics reports that 67% of consumers under the age of 30 have a subprime or non-prime credit score. Worse yet, around 33% of people in this age group do not have any score at all, due to a lack of credit history. Patrick Reemts, vice president of credit risk solutions at ID Analytics, claims that this is, in part, due to the fact that traditional credit scores aren’t tapping into more modern data sources, like cell phone bills. “Traditional credit scores may have served previous generations well,” he writes. “Their lack of visibility into critical modern credit responsibilities [has left] many millennials with incomplete or nonexistent histories at the major credit bureaus.”
Analysis of credit score data by the Federal Reserve Bank of New York found that 67% of those who are 30 or younger have a credit score below 680. A majority of that group has scores below 621, putting them in the subprime-lending region.
This wouldn’t be a problem if millennials were being declined credit for valid reasons. Credit scores are intended to predict an individual’s ability to repay their debt. This filtering mechanism prevents credit cards from falling into the hands of people who, with them, would dig themselves into a financial pit. However, the ID Analytics also found that many individuals in this age group have the ability to repay their obligations. Therefore, there is a clear mismatch between the risk modeling provided by traditional credit scores and the real financial standing of people under 30. This also prevents many millennials from building out a credit history and from ultimately getting travel rewards cards that many of their peers are using as a way to save money on lavish trips.
How Credit Scorers Are Stepping Up
FICO, the company that produces the most widely used credit scoring models in the United States, recognizes these problems. In recent years, they haven’t taken steps to help underscored groups, like millennials. In 2015, the company introduced FICO Score XD – a new model that draws on alternative data sources to produce scores for otherwise unscorable consumers. Even ID Analytics, the company behind the original report, launched a new credit scoring model, Credit Optics Full Spectrum. The new model looks at alternative data to help put those who were previously unscorable onto the credit map.
Once better models exist, the issue then becomes whether or not lenders actually use them. Currently, FICO 8 is the standard model that most banks rely on when determining credit worthiness for new card accounts. According to Jim Wehmann, Executive Vice President of Scores at FICO, it took “5 years for FICO score 8 to reach usage in 50% of risk management decisions.”
Large institutions typically have many legacy systems in place that make it difficult to upgrade to new technologies. Big banks cannot simply jump on the newest and best credit scoring model, without significant effort. However, research by firms like ID Analytics suggests there is high demand for card accounts among populations that wouldn’t necessarily default on their loans. Perhaps this is enough of an incentive for banks to put resources towards pushing these models through at a faster rate.
A Gap Filled by Alternative Lenders
Some companies have decided to jump on the lending gap created by traditional scores. Affirm is one of the companies gaining the most traction in this space. To date, the company has raised $420M from investors, including $100M from Morgan Stanley just this month. Max Levchin, Affirm’s CEO and the cofounder of PayPal, told CNBC that the company is focused on “creating a purchase oriented, purchase built loan to help folks afford nicer things… especially millennials.” The startup operates by providing consumers loans when at the checkout of some online retailers, including Casper, Reverm and Pixel. Affirm uses some pretty alternative data sources to provide their loans to as many people as possible. According to the New York Times, the company uses things like social network profiles and online communications to assess their users.
The danger to alternative lenders popping up to fill the credit card gap, is that it leaves the door open for predatory practices. This is something that is currently plaguing the small business online loans space, where rates are high and terms are often difficult to sift through and understand. Fortunately, consumer lending in the United States is subject to much regulation that aims to minimize the risk of something like that affecting millennials seeking credit.