What is Alternative Credit Scoring?

Once you turn 18, you are eligible to begin building your credit score. Alternative credit scoring can help until you get a credit score. But what is alternative credit scoring, anyway? In this article, we’ll cover alternative credit scoring versus traditional credit scoring, alternative scoring models, the pros and cons of these models, and how to continue building your credit.

Highlights & Key Takeaways

• Approximately 50 million Americans are considered “credit invisible” because they do not have a credit file and credit score. 
• Alternative credit scoring models can help potential borrowers access loans they would otherwise be denied. 
• Alternative credit scoring models can help people without traditional credit scores establish their credit files. 
• Some alternative credit scoring companies include Branch, Nova, and TrustScience.

Alternative Credit Scoring Models 

Alternative credit scoring models evaluate a borrower's creditworthiness using non-traditional data sources and algorithms, in addition to or instead of traditional credit scores from major credit bureaus. Lenders can use this alternative credit data to assess the creditworthiness of borrowers who may not have a lengthy credit history or have a low credit score.

Some examples of alternative credit scoring models and tools include:

• Experian Boost: A tool that allows individuals to add bill payments (utilities, streaming services, rent) to boost their credit score. 
• Experian Go: A free program allowing invisible credit people to start building a credit report. 
• FICO XD: A model that leverages alternative data, such as cable and utility bills. 
• UltraFICO Score: This tool allows individuals to link their checking, savings, and money market accounts to boost their credit scores. 
• CreditVision Link Short-Term Risk Score: A model from TransUnion that uses traditional and alternative data. 

And Equifax also can provide lenders with alternative data for use in their credit determinations. 

Who Uses Alternative Credit Scoring Models

It’s estimated that 65% of lenders use alternative data to make lending decisions. This means they are looking at any documented payment history, social media data, income, and employment history, educational background and job history, and bank account data. 

Here are examples of companies that leverage alternative data to help customers to get access to financial products. 

• Branch: Branch is a mobile-first financial platform that provides loans and other financial services. They use various sources of alternative data to assess a borrower's creditworthiness and look at traditional credit scores. More specifically, Branch looks at data, including mobile device data, financial transaction data, social media usage data, repayment history, and information on your employment.
• Nova: Nova looks at international data to determine a borrower’s creditworthiness, which can be helpful to a borrower new to the U.S. In most cases, they will look at credit history from international credit bureaus, employment and income data, and borrower identification.
• Trust Science: Similar to Branch, TrustScience uses a combination of traditional credit data and alternative data to determine a consumer’s creditworthiness. More specifically, they look at your credit reports as well as bank account and transaction information, including payment history, public records, social media and online behavior, behavioral data, as well as your job history.

What Are the Benefits of Alternative Credit Scoring?

Alternative credit scoring is becoming more mainstream as credit bureaus and lenders have begun to leverage alternative data. By using this type of data, lenders, and creditors can achieve the following:

• Better access to credit for underserved populations by looking at non-traditional data sources, such as rental payment history, utility bills, and online behavior, to evaluate creditworthiness
• More efficient and faster lending decisions at a reduced cost
• More borrowing options and better terms for consumers with an increase in competitive lending products on the market
• Improved accuracy with a more accurate and comprehensive view of a borrower's creditworthiness

Alternative credit scoring offers benefits to borrowers and lenders alike. 

Alternative Credit Scoring Benefits For Lenders

These alternative credit scoring models provide a variety of benefits to lenders. They can provide a more accurate risk assessment, faster decisions, and a better customer experience.

• More customers: Alternative data could give 90% of credit invisible people a score. Of those people, half could be considered prime or near-prime borrowers, according to Equifax. This means lenders will have access to more borrowers with good borrowing habits.
• Improved accuracy: More information can help lenders get more accurate insight into the creditworthiness of borrowers. 

Alternative Credit Scoring Benefits For Borrowers

These very same alternative credit scoring models have benefits for borrowers too. Where traditional scoring models can prevent potentially good prospective borrowers from accessing credit, alternative models use more information to better understand the person’s behaviors and risk levels. 

• More access to financial products: Alternative data gives more people a score, which makes lenders more willing to work with them. 
• Establishing credit: Alternative data also helps individuals build their credit files, which could help them more easily qualify for loans and credit cards with better rates and terms in the future. 

Potential Downsides of Alternative Credit Scoring

However, as with anything, there can be some downsides of using these alternative credit scoring models. The greatest areas of concern include:

• Lack of visibility: With a traditional scoring model, consumers know the factors that comprise their credit score and how it is calculated. With alternative credit scoring models, it can make it difficult for borrowers to understand how their creditworthiness is being evaluated.
• Data privacy risks: Alternative credit scoring models typically rely on data from various sources, including sensitive personal information, which can raise concerns about data privacy and security.
• Violation of fair lending laws: As alternative credit scoring models are relatively new, there may be limited regulatory oversight or standards for evaluating their effectiveness, fairness, and accuracy.
• Limited credit history: While alternative credit scoring models can give access to credit for individuals with limited credit history, they may not be as effective at predicting credit risk as traditional credit scoring models for borrowers with established credit histories.

Traditional vs. Alternative Credit Scoring 

Lenders and financial institutions use financial data collected on credit reports generated by the national credit bureaus: Equifax, Experian, and TransUnion to determine borrowers’ creditworthiness for loans and credit cards. However, the Consumer Financial Protection Bureau (CFPB) estimates that approximately 26 million adults (one out of 10) are considered to be “credit invisible.” This means that millions of Americans lack the information traditional credit scoring systems use. And as a result, information such as the following isn’t used to help determine a person’s ability to take on credit responsibly.

• Bank account information 
• Utility bills
• Telecom or mobile device plan payments
• Rent payments 
• Insurance payments 
• Property records 

Traditional Credit Scoring Models

Traditional scoring models such as FICO and the VantageScore use clear definitions and factors when determining credit scores. The scoring range for the FICO score is 300 to 850, while the scoring range for the VantageScore is also 300 to 850. The FICO score and VantageScore consider similar credit factors when calculating credit scores, such as payment history, credit utilization, and length of credit history, but they weigh these factors differently. 

The FICO score places more emphasis on payment history, while the VantageScore places more emphasis on credit utilization. And the FICO score and VantageScore treat credit inquiries differently. FICO groups multiple inquiries for the same type of credit within a specific time period (typically 14 to 45 days) into a single inquiry to minimize the impact on the credit score. 

The VantageScore considers all inquiries for a particular loan type within a 14-day period as a single inquiry. Since each application can impact your credit score negatively by five points, these different approaches can add up. 

Finally, the VantageScore doesn't penalize consumers for rate-shopping for certain types of loans, such as mortgages, whereas the FICO score does. More specifically, the FICO score is calculated by using the following information, which comes directly from your credit report.

The VantageScore, created by the three credit bureaus in 2006 as a competitive offering to the FICO score, looks at your credit score similarly. 

As you can see, the three primary differences between these two traditional scoring models are the scoring ranges, credit factors, and credit inquiries.

How to Build Your Credit 

The average American has a credit score of 714, which falls neatly in the good range of the FICO scoring system. A good score is typically one considered 670 or higher. But the higher you get, the more likely you are to access lower interest rates, higher borrowing limits, and more borrowing flexibility. Alternative credit scoring can help you start on the journey to building your credit file. Here are some ways you can help build your credit file so that you can eventually access personal loans for good credit, low-interest credit cards, and more.

• Apply for a secured credit card: These cards differ from traditional ones in that you must deposit cash to the credit card issuer to open your account. So, if you provide a deposit of $1,000, your credit limit will be $1,000. These cards allow you to demonstrate responsible spending habits and payment history.
• Apply for a retail credit card: We’ve all seen the offers at various retailers for a percentage off or a special deal of the day if you apply for their card. And though having too many retail credit cards isn’t good, many retailers have less stringent approval guidelines. This means you may have a good chance of approval. Using your retail credit card responsibly can help you build your credit.
• Become an authorized user on someone else’s credit card: If you have a responsible and trusted family member or friend with a good or excellent credit score, ask if they can add you to their account as an authorized user. This allows you to capitalize on their great borrowing habits while you build your credit file. Just ensure you can manage your end of the financial responsibilities associated with using the card.
• Apply for a credit builder loan: These loans use a similar approach to secured credit cards, where you make fixed payments to a lender and then get access to the loan amount at the end of the loan's term. The goal here is to help you develop a credit history to get approved for a more traditional personal loan.
• Always pay your bills on time: Regardless of which traditional scoring model you use, the FICO score and VantageScore put the most weight on your payment history. You must pay at least the minimum amount due on or before the payment due date every month. If you don’t and if you fail to make up a payment within 30 days, it can result of a hit to your credit score of up to 180 points.
• Manage your credit utilization: Your credit utilization is the calculation of the amount you owe on your credit lines compared to your credit limits. As a rule, you should keep your total balances at 30% or less. 
• Don’t apply for too much credit in a short period: While opening up a new credit line now and then can help your credit, applying for too many in a short period isn’t so good. Ideally, keep at least six months between credit applications and only apply for credit if and when needed.

Final Word

The primary difference between traditional and alternative credit scoring is the type of data used to evaluate creditworthiness. If you are wondering about alternative credit scoring, you should know that it looks at non-traditional data sources, such as utility payments, rent payments, employment history, education level, and social media activity, in addition to credit history data. Alternative credit scoring allows the larger population in the U.S. to access credit products and begin to build traditional credit.