Entrepreneur Kenneth Ellman makes a nice six-figure salary. Yet when he went to refinance his six-bedroom house in Newton, N.J., last year, he hit a snag. The problem: Ellman had paid off his original mortgage a while back and had shunned plastic for years. Without a standard credit score, he turned to Pay Rent, Build Credit, which compiles information like phone and electricity bills to help lenders assess a borrower. By using PRBC, Ellman secured a new loan at an interest rate below 6%.
For years big banks and mortgage brokers had little use for data from PRBC and other alternative credit bureaus. Lenders usually just stuck home buyers with little or no credit history into higher-cost mortgages. In the aftermath of the subprime mess, banks are now eager to gather all the information they can on potential borrowers, especially those who don't fit typical lending standards. Some 70 million adults, including recent immigrants, new college grads, and freshly divorced or widowed women, don't have a traditional credit score, making it nearly impossible for them to get a loan in this environment even if they have a good salary and pay their bills on time.
SLICING AND DICING THE DATA
Financial firms like PRBC, credit report processor First American Credco, data provider LexisNexis, and credit bureau TransUnion are scrambling to fill that void with new products and services that cater to this emerging niche, the so-called unbanked. Traditional credit bureaus usually collect data on credit cards, auto loans, and other types of consumer debt. By comparison, these alternative players gather payment information that isn't reported to the typical data collectors, including cell-phone bills and rent. Increasingly, banks are using that sort of information to help vet potential borrowers. "They've captured the attention of lenders right now who want growth in new markets [like the unbanked]," says Michael Turner of Political & Economic Research Council (PERC), a public policy group.
Collecting and verifying all that data is no easy task. Consumers often stuff rent receipts and electricity bills in an old shoe box or a filing cabinet—if they keep them at all. At PRBC, founded by Chairman Michael Nathans more than a decade ago, home buyers enter their payment histories on the Web site, providing the firm with bank-account data and faxing supporting documents or receipts. Then PRBC, which charges customers a $65 fee, hires an outside firm to do a background check and ensure that the information is legitimate. Rival LexisNexis, which is paid by lenders, pores through public documents to find phone records, auto deeds, and other pieces of a consumer's financial life.
Each company slices and dices the data differently. Some, like PRBC, LexisNexis, and eBureau dump the information into their own mathematical models to come up with a score, not unlike Fair Isaac's FICO, the traditional three-digit scoring system that rates customers on their credit-card and other debt histories. The goal is the same: to help lenders assess whether a customer will make good on a loan.
But while more banks are using the data provided by these alternative credit bureaus in their underwriting process, big lenders remain hesitant to adopt the new credit scores. Bank of America (BAC) will look at rent and utility bills when screening customers for a loan, but it won't use ratings based on that information. Hudson City Bancorp (HCBK) doesn't use credit scores at all. It prefers to do its underwriting the old-fashioned way, by having its brokers call to verify employment, check assets, and collect financial histories. Says Thomas E. Laird, chief lending officer for the Paramus (N.J.) firm: "Credit scores don't necessarily give a true picture of a borrower's ability to fund new debt in the future."
Some lenders take their cues from mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). While both use FICO scores in their underwriting, the government-sponsored firms won't use the alternative credit scores until there's more historical data on how well they predict whether consumers will make their loan payments. Critics argue there isn't a large enough sample size in some studies to know whether the data are statistically significant.
But as companies collect more data and mine the information for behavioral patterns, industry experts believe alternative scores will gain wider acceptance. LexisNexis has found that borrowers who stay at the same address for years pay back their loans more frequently than folks who move around. Another study from policy group PERC that looked at 7.5 million people showed that consumers who make timely utility payments tend to be low-risk borrowers. "It took 20 years for lenders to see FICO as a score they could rely on," said Arjan Schütte, associate director of the nonprofit Center for Financial Services Innovation. "They need to get comfortable with the new ones."