Over the past two decades, the financial services industry has been gravitating towards a more comprehensive approach to credit risk assessment. Credit scoring models alone don’t tell the whole story, so companies are looking to alternative credit data to fill in the gaps. Here’s a closer look at what alternative credit is and how you can use it to your advantage as a borrower.
Table of Contents
- What is alternative credit?
- Why is alternative credit important?
- Alternative credit pros and cons for borrowers
- Examples of companies using alternative credit
- How can you use alternative credit to your advantage?
What is alternative credit?
Alternative credit refers to the practice of financial service organizations assessing a borrower’s creditworthiness using more than traditional credit data.
According to Experian’s The State of Alternative Credit Data whitepaper, traditional credit data includes everything found on business and consumer credit reports as well as the information that’s commonly requested on lending applications, including:
- Tradeline information
- Credit inquiries
- Public records (e.g. bankruptcy and lien filings)
- Residence history
- Employment history
- Income amount (monthly or annual)
With that in mind, alternative credit data is everything else. Common examples include:
- Utility payments
- Phone payments
- Rent payments
- Asset ownership
- Short-term, small-dollar loans (payday loans)
- Lease payments
- Bank account transaction data (from checking and savings accounts)
- Sales history
- Social media stats and activity (in the case of businesses)
- Income and employment information
So if a lender or other financial service company calls itself “alternative” or says it considers alternative data, that simply means it looks beyond traditional credit reports and questions during its application and underwriting process.
Why is alternative credit important?
As a borrower, it’s important to understand the shift to alternative credit data sources so you know how you’re being evaluated by lenders. Similar to how you check your credit scores before applying for a loan, you’ll want to check additional aspects of your financial profile and create a more comprehensive credit strategy.
For the industry as a whole, alternative credit data is giving credit markets a more holistic understanding of consumer and business borrowers. While past payment behaviors can be used to predict future behaviors, the present ability to repay a loan lies in the amount of money a person or business has available after paying their expenses each month — their cash flow.
Traditional credit data doesn’t include real-time income or expense information which leaves credit grantors with a blind spot. “Lenders only know about key risk outcomes, such as defaults, when it’s too late. This asymmetry of information can be a lose-lose scenario for financial providers and consumers,” said Ken So, founder of Tillful, in the article, Lenders Looking To Conquer The Data Waterfall Should Start At The Top.
When loan issuers can review an applicant’s credit history as well as alternative credit data like bank account activity, it provides insight into the past and the present. They see not only that bills get paid, but how much is typically left over afterward. This grants more insight into a borrower’s stability, ability, and willingness to repay — enabling more informed approval and pricing decisions.
Alternative credit pros and cons for borrowers
Alternative credit presents a few potential pros and cons for borrowers. On the pro side, it can open doors to credit for those who lack an established credit history. For example, if your business has a healthy cash flow but no credit accounts, an alternative credit lender may approve you when a traditional lender wouldn’t. The additional data could also help you land lower borrowing costs.
On the flip side, if your business has great credit but is experiencing cash flow problems, alternative data like bank account activity could have a negative impact on lending decisions. It could prevent you from getting approved for a credit opportunity or could result in higher interest rates and fees.
Another issue to consider is security and privacy. Are you comfortable sharing more financial information with financial service companies, and is it safe with them? In modern times, most people bank online, manage credit cards online, manage their credit online, and use budget apps to manage their finances — so granting lenders access to more financial information isn’t a far stretch. But, that’ll be up to each borrower and will likely depend on whether the alternative credit data will likely open a credit door that would otherwise be closed.
Examples of companies using alternative credit
Wondering how alternative credit can be used in the market and which companies are already using it? Here are a few examples.
For credit scoring purposes
Experian is one of the main credit reporting agencies for both businesses and consumers. While traditional credit is largely based on the information found on credit reports, including those from Experian, the credit bureau itself has jumped on the alternative credit bandwagon.
In early 2019, it launched Experian Boost which lets consumers add monthly bills like rent, utility payments, and streaming service bills to their credit files. To do so, users log into Experian and connect their bank accounts and credit cards. From there, Experian finds the bills they pay each month and asks if they want to add them to their credit file. If they say yes, it can provide an instant boost to their personal credit scores.
Enables financial institutions to access alternative credit data
Plaid, a trailblazer in the world of alternative credit, is a financial services company that helps organizations quickly access the bank account information of their customers. Currently, over 7,000 fintechs power their apps and services using Plaid, including well-known brands like SoFi, Prosper, and Carvana. The platform also supports over 12,000 financial institutions, which means most consumers will find support for their bank on the platform. Plaid has been instrumental in helping financial service providers quickly look into alternative credit data sourced from the bank accounts of borrowers.
Uses alternative underwriting processes
Next, OnDeck is an online small business lending company that’s delivered $14 billion in business loans since its founding in 2006. When it comes to assessing the creditworthiness of applicants, the lender says it “looks beyond credit scores” with the use of digital technology and data analytics. It aggregates and analyzes thousands of alternative credit data points to quickly assess a business’s creditworthiness.
Offers an alternative business credit score and credit-building solutions
At Tillful, we created a Business Credit Score service that gives business owners an easy way to keep tabs on their overall financial health. They can log in to see traditional credit data like payment history on credit accounts, credit utilization, and credit scores. However, they can also connect credit cards and bank accounts to monitor their cash flow trends in real time. The holistic picture can help better a business owner’s odds of getting approved by traditional and alternative lenders alike.
PS - we currently have a new credit building service in beta for Tillful score members. Sign up for your score to get your invite.
How can you use alternative credit to your advantage?
With the growing use of alternative data, it’s important to do your due diligence to prepare. In many cases, building credit is still going to play a major role in getting approved for credit accounts. However, you should also think about the other data points that are being considered. Do you have more than enough money to pay your bills each month? Is your bank balance remaining steady, or at least not hitting zero? Do you have assets? The more of a financial cushion you can prove, the less lenders will worry about your ability to meet a loan obligation.
In some ways, alternative credit can force you to think more holistically about your business’s financial health. That’s our take, anyway.