Why Your Traditional Credit Score is Becoming Obsolete

Think your credit card issuer only looks at your income and FICO score when deciding what kind of credit card you deserve? Not anymore.

As millions of Americans recover from the sharpest downturn since the Great Depression, a growing number of credit card issuers are quietly testing new, more comprehensive ways to evaluate customers' creditworthiness.

In many cases, that includes looking at a wide range of nontraditional factors, such as the value of your home, whether or not you have a criminal history, how often you change addresses and what kind of professional license you may hold.

Lenders hope that by supplementing traditional credit scores with nontraditional information, they'll be able to offer more cards to more people -- without getting stiffed the way they did before, say experts.

"Lenders want to grow their business again," says Ankush Tewari, director of strategy and market planning for LexisNexis RiskView, which offers card issuers alternative credit scores based on public records information. "They want to open their doors again, but they don't want to repeat the same mistakes they made prior to the recession."

How it began

Before the downturn, issuers grew their businesses by offering cards to nearly anyone who'd take one. Now, after writing off billions of dollars in unpaid loans, they are trying a more selective approach.

"Issuers are using other data sources to make more informed decisions," says Philip Philliou, a New York City-based consultant to card issuers. Nontraditional data, such as payment history on a cellphone or an applicant's frequent use of prepaid cards, "helps the issuer develop a clearer picture of who the cardholder is," he says.

The use of nontraditional data also helps lenders identify people whose traditional FICO scores took a beating during the recession, but who are normally much better at handling credit than their scores would suggest, say experts.

"These are people who actually are a good credit risk," says Tom Johnson, vice president of business development at Zoot Enterprises, which helps issuers approve applicants for new cards. "They just happened to have lost their jobs during the recession."

Many potential cardholders have sold the homes that were dragging down their finances or found new jobs, but their credit scores remain stuck in time, adds LexisNexis's Tewari. (It takes at least seven years for a negative mark to fall off someone's credit report.)

"Fifteen million consumers had their credit scores [negatively] affected as a result of the recession," says Tewari. "It's been five years now ... many of them have recovered and moved past those credit difficulties, but their traditional credit score doesn't indicate that."

Questions remain Experts say that most credit card providers, including the largest issuers, are either using nontraditional data already or are actively examining it.

"All the issuers out there are looking at better ways of making decisions and lending," says Tewari.

That's especially true now that, per the Credit CARD Act of 2009, issuers can't increase cardholders' interest rates without giving them 45 days' advance notice, says Tewari. "So that upfront decision is even more important," he says.

Not everyone, however, is convinced that incorporating nontraditional data is the answer.

"From our perspective, the challenge is the comprehensiveness of the data collection," says Dave Bowen, senior vice president at KeyBank, which is actively exploring alternative data, but currently doesn't use it. "With things like debt instruments, loans, all banks, all credit unions, all finance companies, we're all reporting that very consistently, very thoroughly." So the details the big three credit bureaus, Experian, Equifax and TransUnion, collect are more dependable, he says.

Alternative credit score providers, by contrast, often collect much-less-consistent information, such as rental payment history or utility payments, which aren't consistently reported by landlords and utility companies. For example, "there are tens of thousands of small landlords who aren't going to [consistently report their tenants' payment data]," says Bowen.

Consumer advocates also worry that some alternative information may not take into account complex circumstances and, as a result, may actually harm people more than it helps them.

"More data is not always necessarily better data," says Chi Chi Wu, a staff lawyer with the National Consumer Law Center, who has testified before Congress about alternative credit reporting.

Sometimes renters, for example, will find that the only way to get a landlord to resolve a legitimate dispute is to legally withhold rent. However, that could seriously harm the renter's credit history if it's reported as a missed payment, she says.

Low-income consumers may also struggle to pay their utilities on time when the weather turns extreme; but if the late payments are reported, their credit may be unintentionally damaged by a service they can't opt out of, says Wu.

"Utilities are different. It's not like a credit card where you have a choice," says Wu. "Everybody needs heat and light."

Dozens of agencies collect consumer information

In a list intended for consumers, the Consumer Financial Protection Bureau (CFPB) cites 39 consumer reporting agencies that collect alternative data, but admits the list isn't exhaustive.

Most consumer reporting companies specialize in a specific type of information mining. For example, LexisNexis RiskView collects mostly public records information, including insights into your age and education, how often you move, whether you hold some kind of professional license and what kind of home you live in.

"Any data that's available through a courthouse, for example, bankruptcy data or criminal data, or data that's available from the county ... all that stuff is public information," says LexisNexis's Tewari.

Big three credit reporting company Experian collects data on rental payments, but only includes positive rental information on credit reports. Clarity Services specializes in reporting your payday loan and check cashing history, among other financial activities, and ID Analytics pulls together the identifying information you use when applying for other loans, such as your name, address and phone number.

Some companies even collect social media data, but many experts are doubtful that information will become widely used for credit scores that are crunched by a computer rather than by hand. "From an individual perspective, it's really hard to gather any tangible meaning" from social media, says Zoot Enterprise's Johnson. "Computers just don't get context very well."

Who are these guys? It's not clear

It's unclear how many of the consumer reporting companies listed by the CFPB are selling reports or scores specifically to credit card issuers -- or who else may be selling this kind of data.

However, consumer advocates say that the dearth of comprehensive, publicly available information about who these companies are and what kind of role they play in credit decisions is a problem for consumers.

"A lot of times people don't even know what these companies are," says Linda Sherry, a spokeswoman for the nonprofit consumer rights group Consumer Action.

Under the Fair Credit Reporting Act, consumers have a right to request a free copy of their alternative reports. However, some companies make it so difficult to do so that the CFPB recently sent them a stern warning. Others won't disclose the information being reported until a consumer has received an adverse action notice after they've been rejected for credit.

That, too, is problematic, say consumer advocates -- especially since errors on a consumer's report could carry such hefty consequences.

"Any time data about consumers is used and they have no way to correct it or ensure it's accurate, that's unfair to consumers," says Consumer Action's Sherry.

Consumers can request a free annual report by contacting the company directly and asking for their file disclosure. However, each company requires a different process for disclosing information, warn consumer advocates. Some companies will allow consumers to request a report online. Others require that consumers call or mail in their request.

Issuers also look within for extra data

Third parties aren't the only sources of information that issuers are looking to for alternative data, however. They are also increasingly looking at the data they already own, say experts.

That's especially true when it comes to consumers with the best credit scores. Since the recession, issuers have competed fiercely for cardholders with pristine credit, most of whom already have a fistful of cards.

To lure these cardholders into applying for additional credit, many issuers are testing fresh ways to use the data they already have to personalize offers and encourage cardholders to spend, says Zoot Enterprise's Johnson.

"We're being asked more and more to help them use their own data better," says Johnson. That includes analyzing what items you buy with the cards you already own, how often you use them and what kind of banking method you prefer.

The goal, says Johnson, is use those details to offer you a card you're not only likely to apply for, but that you will also frequently use.

"The competition is driving some really innovative practices," says Johnson. "These banks are having to deal with customers on a whole new level."

For example, if you're a frequent spender with an enviable credit score, issuers may tailor the rewards they offer you based on the purchases you frequently make. Or they may grant you a higher credit line or lower APR based on internal information in conjunction with your traditional and nontraditional scores.

"These guys have some very interesting data, some very good data," says Johnson. And "they're just starting to realize the value of it."