Every lender has been in the situation. A new customer with a limited credit history wants a good rate on a first-time auto loan. The numbers are lacking, but the instinct gnaws. Take the risk? Make the deal? In these situations, consider evaluating alternative data to assess credit risk.
According to an Experian study fielded between July 31 and August 16, 2017, approximately 11 percent of the U.S. population has no credit file, which makes them “credit-invisible.” With no credit history, these individuals often face a significant barrier to obtaining credit.
A “thin file” customer who is lacking a strong credit score may have a viable credit history from alternative credit sources. According to the National Automotive Finance Association, analysis of items like electricity bills, child day care, insurance, and school tuition can provide a viable source of credit history – and worthiness.
Credit histories from these types of sources are typically not reported to the traditional Big Three credit bureaus. However, according to Experian, using alternative data can provide previously “unscorable” consumers with strong credit history markers. Lenders evaluating alternative data can assess the consumer’s ability, stability and willingness to pay. Experian’s analysis further revealed a strong correlation between historical alternative loan performance and future auto loan performance.
Assessing Alternative Data
In 2017, the Consumer Financial Protection Bureau released a study indicating the ways “credit invisible” consumers establish a credit history can differ greatly based on their economic background. The CFPB estimated that more than 45 million American consumers are credit-invisible, meaning they either have a thin credit file that cannot be scored or no credit history at all.
The study identified credit records of more than one million consumers who became “credit visible” to determine how they gained visibility.
- Consumers in lower-income areas are 240% more likely to become “credit visible” due to negative information, such as a debt in collection.
- 30% of consumers in higher-income brackets are more likely to gain visibility by using a credit card or by being added as a co-borrower or authorized user on someone else’s account.
- The percentage of consumers transitioning to credit visibility due to student loans more than doubled in the last 10 years.
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 comply 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.
Remember, the customer is more than a number. Understanding the customer’s life background can give valuable insight and demonstrate a viable credit risk. When considering whether to close the deal with a “thin-file” customer, offering consumer protection products, like a vehicle service contract or vehicle return protection can provide the needed security from risk as well as creating an additional revenue stream. These types of products also enhance a customer’s creditworthiness and can provide added incentive for the lender to finance the deal.
With more than 40 years of experience in the retail automotive industry, EFG can help your institution stay at the forefront of the changes affecting your industry today. Contact us today to learn how to extend your reach with “thin file” consumers.1 - Reader Likes This Post