In 2015, the Consumer Financial Protection Bureau (CFPB) released a study finding that 26 million Americans did not have a credit history, and another 18 million were “unscorable” because their histories were too limited. Since then, policymakers, advocates, and the financial industry have all proposed ways to help people without credit scores, many promoting the use of alternative data.
It’s likely that the CFPB study numbers have increased since the research was commissioned. Historically, many lenders have assumed that consumers with limited or nonexistent credit histories are bad credit risks. However, a LexisNexis study found that nearly two-thirds of these consumers are low-risk and could be considered good and profitable customers for lenders. If alternative sources of data can help correctly gauge these consumers’ risk, auto lenders may be able to generate credit scores that more accurately reflect default rates and therefore expand credit access to this broader population.
Be mindful of regulations
There are many unanswered questions about the use and accuracy of alternative data in general. Data mining to determine credit, employment, or insurance is covered under the Fair Credit Reporting Act. Before you tap into any data providers, make sure they are in compliance with the law. If alternative data is used in credit decisions, the Equal Credit Opportunity Act also applies, and lenders must ensure that there is no disparate impact on protected groups. Continue reading