What Is Alternative Data?
An alternative credit score uses data that isn't used in traditional credit scoring models, called alternative data. Here's why alternative data is important and how FICO® Score XD helps.
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Traditional credit scoring models are designed to predict risk based on how someone manages their credit. But traditional credit data sometimes doesn't tell the whole story, particularly for the 53 million consumers who don't have a credit report or who have insufficient or stale credit history and cannot get a FICO® Score.
Here's what you need to know about how alternative data works, as well as how FICO® Score XD can give consumers who are creditworthy but previously unscorable the chance to access credit.
How Does Alternative Data Work?
Traditional credit data is housed at credit bureaus and includes information about your loan accounts, credit cards, credit inquiries, bankruptcy public records, and collections. Alternative data may include:
- Debit and credit card transactions
- Public record and property information
- Income and expenses
- Checking and savings account balances
- Utility, phone and rent payments
All of these alternative forms of financial data may help provide lenders with a better idea of how loan applicants manage their financial obligations and how likely they are to pay back a loan as agreed.
Oftentimes, though, these alternative forms of financial data are not used in lending decisions. For example, while 92% of American consumers own a cell phone, only 5% of consumers have their telecom data included in their traditional credit profile. And although there are 80 million renters in America, only 2.3% of them have rent payments reported to the credit bureaus.
The use of alternative data can open up more opportunities for people who were previously unscorable because they have sparse, stale or no traditional credit data.
The use of alternative data has increased over time, but it's still not used by all lenders.
How FICO® Score XD Helps
FICO® Score XD was first introduced in 2016, and the second version was released in 2018. In addition to available traditional credit bureau data, the model considers information such as landline, wireless phone, utility, and cable payments and public records.
FICO partners with Equifax® and LexisNexis® Risk Solutions to gain access to public records as well as the National Consumer Telecom & Utility Exchange for payment data.
While all of these data points aren't traditionally reported to the major credit bureaus, they're still indicators of creditworthiness, and FICO® Score XD allows lenders to incorporate that data into their decision-making process. This is particularly valuable in circumstances where the available credit data is too sparse or stale to generate a reliable credit score. In other words, it can help make up for when traditional credit report data fall short.
Who Benefits from Alternative Data?
There are a few different groups of consumers who can benefit from lenders using alternative data in lending decisions:
- New to credit: Particularly young consumers, this group may find it difficult to obtain affordable credit simply because they haven't used credit yet. They may have applied for credit but were denied, or the account is brand new, and they don't have any other traditional credit information.
- No traditional credit file: For this group of consumers, there's no credit data at all, including no recent inquiries. This group is also made up mostly of younger consumers.
- Lost access to credit: These consumers may find it difficult to obtain affordable credit because there is derogatory information in their credit file.".
- Credit retired: Typically older consumers, this group describes people who may have chosen not to use or apply for credit because they may not need it. Many haven't had an update to their credit file in several years.
All of these consumers may experience a “catch-22” when they try to apply for credit — they can't get approved because they don't have a credit score, but they can't generate a credit score without getting approved for credit.
The Bottom Line
Alternative data is growing in use by many lenders to augment the use of traditional credit scoring models in their underwriting processes. With the use of alternative data, lenders will not only be able to make better credit decisions, but they'll also be able to provide credit access to consumers who are creditworthy, even if they don't have a traditional FICO® Score.
FICO® Score XD is one way that lenders can incorporate alternative data in their decisions. Some institutions have even developed their own approach to alternative credit.
With the use of alternative data on the rise, lenders can use other relevant information in addition to traditional credit data to make lending more accessible.
Ben Luthi has been writing about money and travel for seven years. He specializes in consumer credit and has written for several major publications and industry leaders, including U.S. News and World Report, Fox Business, Wirecutter, Experian, and Credit Karma.