Millennials have not taken kindly to credit cards like the generations that preceded them, studies have shown. It’s not cash—it’s debit cards. For many young adults, choosing to avoid a credit card means choosing to avoid the potentially damaging consequences of high interest rates and overdue balances. In a nutshell: Why borrow when you’re just going to pay it back?
The answer often comes later on – when you can’t just pay in cash from your bank account, like for a mortgage or car loan. And for these credit-invisible people, that doesn’t yield great interest rates.
On Thursday the Consumer Financial Protection Bureau, the government agency tasked with the sole mission of protecting consumers, announced it would be looking into alternate ways of determining consumers’ creditworthiness by asking the public for feedback about having alternative data for producing a credit score—instead of typical consumer credit-building, which relies on things like student loan repayment and credit cards.
“We want to learn more about whether this kind of alternative data could open up greater access to credit for many Americans who are currently stranded outside the mainstream credit system,” CFPB Deputy Director Richard Cordray said in Charlestown, W. Va.
Cordray detailed how loans used to be made on the basis of personal relationships—which still happens in community banking situations—but have moved toward an algorithmic system that assigns a credit score. In addition to the deficiencies of the credit score, which often omits potential credit-building factors like rent payments, the CFPB found that 25 million Americans are credit-invisible, with no credit history, and another 19 million have extremely limited credit history.
“[These people] often are caught in a Catch-22, unable to get credit because they have not had credit before,” Cordray said. “They cannot seize meaningful opportunities, such as borrowing to start a business or buy a house.”
The idea that other sorts of data can be used in lieu of the credit score algorithm isn’t new. In 2015, FICO announced that LexisNexis and Equifax began a pilot program in which credit card companies can use alternative data like bill payments to identify creditworthy people, and public records.
Credit invisibility has been worrisome in China, as credit is a new thing for many people. There, however, the alternative means proposed, have been troublesome: A social score that tracks spending habits and filial piety, among other things. It’s a program that sounds as if it came from a dystopian thriller, designed to control the subjects of a totalitarian state.
This is precisely why Cordray is opening up a dialogue to determine what ways, if any, should be implemented to extend credit for people with no or little credit history.
“Alternative data may draw from sources such as rent or utility payments,” said Cordray. In his view, a possible option would create a new hybrid system that takes elements like those payments and combines it with traditional lending practices, which take into account the consumer’s lifestyle and personality. “It can encompass the kinds of information that relationship lenders typically know as a matter of course, such as the consumer’s occupation, educational attainment, and various other personal accomplishments.”
Specifically, the CFPB will be looking into whether alternative data would help expand access to credit, how complex it would be, how expensive it would be, whether severe privacy and security issues would occur, and what impact it would have on specific groups of people.
The process for determining the pros and cons may be a lengthy one, but the potential upside is great. While much public conversation focuses on the ability of small businesses to borrow, the lack of credit for almost 45 million people is a significant economic issue.
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