Unless they are in trouble, most people don’t wake up in the morning thinking about credit. Not even me, and I’ve spent much of my career immersed in it. But for most people, credit is an afterthought, and that’s unfortunate given the impact it has on our lives. Credit is now at a crossroads. It’s evolving right in front of us and that could mean real changes in the way we interact with it. Alternative credit is something we’ll all need to think about, though perhaps not first thing in the morning.

Before I joined eCredable, I spent the prior 7 years at the credit reporting agency Equifax. I got up close and personal with the credit ecosystem, both from the perspective of the creditor as well as the consumer. In my capacity as President of Equifax Personal Information Solutions, I worked with a team of people to create a variety of products targeted at helping consumers understand and navigate the complexities of the credit system. It’s a topic that requires the development of thoughtful and deliberate products that meet the needs of the infrequent credit shopper.

When you read the extraordinary amount of information that is written daily on the topic of credit, from the perspective of the creditor and the consumer, there’s a never-ending discussion on the relevance of credit to our everyday lives. Is alternative credit relevant to the way we conduct our daily financial lives? Now, more than ever, the answer is a resounding “Yes,” and here’s why.

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Traditional credit originates with the national credit bureaus (Experian, Equifax and Transunion) and consists of the payment information you make for repaying debt, like credit card balances, car loans, and mortgages. It also includes negative information like collections, liens, and bankruptcies. It has been around for quite some time. Like any new source of information, it took awhile for credit reporting and credit scoring to gain acceptance across the entire financial landscape. Understanding that the pace of change is highly correlated to the pace of technological advancements, it’s no surprise that automating the decisions associated with credit has been one step behind on this journey. Even though businesses have been able to use credit information in every facet of their decision making processes about consumers (their customers), they never seem to have enough information to further refine their ability to make financial risk based decisions. As the Great Recession exposed the risky lending practices of many lenders, part of the backlash includes a new focus on finding new sources of information to make more informed decisions.

Credit bureaus refer to information that is not contained in a consumer credit file as “alternative data.” In the context of consumer credit, it just makes sense to refer to this same information as “alternative credit” when you consider that this alternative data will be used for credit-related decisions. But why is this data “alternative” in the first place? Why can’t the credit bureaus get all this information housed in the same databases as the information used for “traditional credit?” It comes down to two simple but important business reasons: information availability and compliance with the Fair Credit Reporting Act (FCRA).

[Related Article: Free Consumer Reports: Nationwide Specialty Agencies]

By information availability, I mean the ability and desire for businesses that have payment information about consumers to report this information to the national credit bureaus. If there’s nothing in it for them, why go through the time and expense to share this information? It takes people and technical resources to report information to the credit bureaus. The information has to meet a significant number of minimum requirements for the credit bureaus to accept the information (the keys are quantity and quality). In short, you can’t just throw numbers out there and hope they stick.

By FCRA compliance, I mean the legal obligations that the Fair Credit Reporting Act (as well as FACTA, the Fair and Accurate Credit Transaction Act of 2003) places upon data furnishers. (Data furnisher is the name credit bureaus give to companies that provide data to them.) If a business reports information to the credit bureaus, the business needs to be prepared to respond to consumer disputes. In other words, when a consumer applies for credit and he or she is turned down due to an incorrect piece of information that was provided by the data furnisher, the business needs to be prepared to manage a consumer dispute and the potential for a subsequent legal action against the business.

All this adds up to people, time, and money. If businesses can’t significantly offset the expense of providing data with insights that will help them run their business better and be more profitable, then there’s no reason to report data to the credit bureaus. But this doesn’t lessen the need for companies to understand alternative credit. Most businesses want more customers, but they only want more “profitable” customers. They don’t want to extend credit to someone they don’t think can pay them back as agreed. It’s just common sense.

Approximately 75 percent of the adult population in the U.S. has traditional credit. The remaining 25 percent of the population has to get by with alternative credit. Alternative credit is defined as “credit reports and credit scores developed from data sources not typically contained in the national credit bureaus such as rent, utilities, insurance, and other forms of payment.”

If you’re a business, your first question is “how reliable is this information in making risk decisions?” FICO answered this question in 2007 when it released the FICO Expansion Score™, which uses alternative data to produce a credit score. The company was able to demonstrate that the FICO Expansion Score is comparable in its predictive values as traditional credit scores when evaluating credit. The predictability of the score was extremely similar to the FICO Score all the way through the score range of 300-850, until the score reached 780 (in the higher end of the scale, and not very relevant to assessing people without traditional FICO scores). This is important information, since FICO sets the standard for credit scoring.

If you’re a consumer without a traditional credit history (often called “thin file” or “no file” in our world), you’re probably wondering how you can use alternative credit to your advantage. The easy answer is that alternative credit allows you to build a credit history based on things you buy, not things you charge, like utility bills, rent payments, cell phone bills and auto insurance premiums.

[Related Article: Specialty Consumer Reporting Agencies: Tenant History Reports]

The law’s on your side: the Equal Credit Opportunity Act (ECOA) already provides you with the ability to provide this kind of information any time you apply for credit, and the credit grantor must consider this kind of information when using credit related information to make a decision.

Most consumers don’t know about this law, and most creditors don’t want to enlighten them. Why? Creditors have no easy way of accepting and using this information in making risk related business decisions. Creditors are completely hooked on using automated credit reports and scores to make these decisions without human intervention. If a consumer shows up at their place of business with a shoebox full of cancelled rent checks, utility bills marked paid, and various other pieces of paper that proves they paid their bills on time, the creditor would have a lot of work to do to understand the value and validity of this information. (It’s a little like how creditors made risk decisions 50 years ago.)

So what’s a consumer to do? The goal of alternative credit bureaus (like eCredable and others) is to help consumers overcome this challenge. If a consumer wants to avoid going into debt to prove their creditworthiness, but still wants to demonstrate their creditworthiness, having the bills they pay routinely that are not reported to the national credit bureaus can be extremely helpful. For years, creditors have used Alternative Credit in mortgage underwriting. This same approach is being extended to auto loans and credit cards as well.

eCredable is one of the companies helping to address the market need, albeit from the consumer perspective. Experian has expanded its credit file to include rental payment information from some of the larger property management systems that are willing to share data. Equifax has long been in the employment and income verification business, and is looking to complement this information with alternative data. Every year, more companies recognize the need to verify credit worthiness with alternative data, and I believe their requirements for alternative data for risk mitigation purposes will grow exponentially over the next two decades.

Is it time for “Alternative Credit” to join the mainstream credit conversation? It’s long overdue.

[Free Resource: Check your credit score and report card for free with Credit.com]

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These days, many consumers are likely finding it easier to obtain many types of credit, as lenders have significantly slackened requirements for most loans and credit cards. However, the qualifications to obtain a good mortgage rate remain stubbornly high across the country.

Even as credit conditions improve significantly nationwide and many financial institutions are once again broadening lending efforts, many are still being extremely tight with financing for mortgages, according to a report from the New York Times. In fact, even as subprime lending for credit cards opens up considerably, many consumers with low credit scores will find themselves extremely unlikely to even be considered for a home loan approval.

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A recent study by the Federal Reserve Board indicated that consumers with a credit score of 620 willing to make a 10 percent down payment are now less likely to be approved for a mortgage than they were in 2006, the report said. Further, some were even reticent to extend financing to borrowers making a similar down payment when their credit rating was 720.

This is because most lenders are still extremely gun-shy about lending large sums of money to anyone but the most qualified borrowers, the report said. In many cases, those who are approved for a home loan will also pay far higher rates on the mortgage than those who have top-notch credit scores, even as the average interest rate has hovered below 4 percent for some time now.

“If you don’t have good credit, you’re not going to get that crazy low rate,” Deborah MacKenzie, the director of counseling at the Stamford, Conn., nonprofit the Housing Development Fund, told the newspaper.

[Free Resource: Check your credit score and report card for free with Credit.com]

Typically, the only way consumers can improve their credit ratings so that they can qualify for a home loan is by being smarter about managing their various lines of credit, including keeping credit card balances low and making all payments on time and in full. These are the two biggest factors comprised in a credit score. However, consumers can also be hurt by applying for too many new lines of credit within a short period of time, so avoiding this ahead of shopping around for a mortgage can be crucial to maintaining good credit health as well.

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Are you one of the millions of consumers who opted to do a short sale on your home during the mortgage crisis?  There may be some good news for you as earlier this month, Fannie Mae announced new mortgage guidelines targeted at troubled mortgage borrowers that potentially reduces the amount of time it takes to obtain a new mortgage from four years to two years.

The overwhelming majority of mortgage lenders follow mortgage underwriting rules published by Fannie Mae and Freddie Mac.  So if you lost your home to a short sale or turned it over to the bank and are now thinking of financing a new home, it’s a good idea to familiarize yourself with their guidelines. The new rules are scheduled to go into effect on July 1, 2012.

As they say, the devil is in the details and not all qualification information is available (or easily found).  In summary, you will be required to come up with a 20% down payment to obtain a mortgage in the reduced two-year time period unless you can prove your problems were the result of extenuating circumstances, for example — a divorce, medical expenses or unemployment.  In these cases, you may be able to secure a mortgage in the shorter two year time period with a lower 10% down payment.

It is my understanding that there are also requirements that interested consumers also meet certain credit and ability to pay standards and pass Fannie Mae’s credit criteria screens — which review your credit report and credit scores.

[Credit Score Tool: Get your free credit score and report card from Credit.com]

This could be a substantial challenge for many of the consumers for whom this revised rule is targeted to benefit.

The presence of a short sale information or flag on a credit bureau report is considered negative by most all credit scores, as it predicts future credit risk. The flag can stay on the report for up to seven years.  Generally speaking, the impact on score will be severe.  The exact impact on a given consumer’s credit score resulting from the reporting of a short sale will depend on several factors:

• The information associated with the short sale reported, and
• The current credit profile of the consumer (the other activity being reported on the consumer).

The negative impact on score is more noticeable if this item is posted on a credit file that has no or little history of missed payments and/or derogatory information and has low balances on active credit.  In these scenarios, the points lost can be 100 or greater.  The impact may be less noticeable if there are indications of high risk behavior (missed payments, etc.) on the credit bureau report as the credit score is already lower — reflecting that higher risk behavior.

There are not really any “tricks” to quickly increase the score quickly when this information is posted on the file.  The points lost due to the short sale flag will have (gradually) less impact over time as the date it was originally posted becomes older (and assuming that you have no other delinquency information on your file).

It appears that this rule change will be most helpful to those impacted consumers who have already re-built their credit since they first enacted the short sale, have steady and sufficient income and are deemed capable of successfully handling the new mortgage they are seeking.

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Since the end of the recession, consumers have been repeatedly cutting the rates at which they feel behind on their credit card payments and repeatedly failed to pay the bills, but that trend might be reversing itself.

Analysts recently suggested that the record-low instances of delinquency and default observed by credit card lenders since the end of the recession were expected to bottom out at some point this year, and already, this might be taking place for at least one major lender, according to a report from Dow Jones Newswires. In its monthly filing with the Securities and Exchange Commission, Capital One Financial, one of the six largest credit card lenders in the nation, reported that it saw instances of defaulted accounts rise to 4.07 percent of all balances in April, up from 3.85 percent in March. Defaulted accounts are those that are 90 days or more behind on payments and are charged off by lenders as being uncollectable.

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But at the same time, the lender noted that short-term delinquencies — those accounts that are only 30 days or more behind on payments — fell once again in April, the report said. In all, this type of late payment slipped to 3.18 percent of all accounts, down from 3.25 percent in March. Generally, experts view fluctuations in lender delinquency rates as predictors of future charge offs, indicating that progress could be uneven as the year goes on.

During the recession, many consumers ran into severe financial difficulty that made it difficult or even impossible for them to pay their credit card bills on time every month, and instances of both delinquency and default spiked considerably. The problem became so widespread, in fact, that many borrowers saw their credit scores fall to the point where they could no longer qualify for any types of credit, and were therefore forced out of the borrowing system altogether, particularly as most lenders significantly increased lending standards to guard themselves against further losses.

[Free Resource: Check your credit score and report card for free with Credit.com]

But now, as the economy improves and consumers get a better handle on their finances, many lenders are once again broadening issuing standards, giving consumers with subprime credit scores access to new accounts once again. Some experts believe this might be leading to an increase in charge offs, but others say they had to increase naturally back to historical averages.

If it seems like everyone’s talking about credit scores these days, it’s probably not your imagination. Consumers appear to be getting smarter about credit scores. At least that’s what the results of a survey of 1000 consumers by the Consumer Federation of America (CFA) and VantageScore Solutions show. Compared to a year ago, a larger percentage of consumers correctly answered a variety of questions about credit scores. But there were a few key concepts that tripped up many respondents.

[Related Article: What's a Credit Score? Really.]

Most of those surveyed did well on the basics. They knew that:

• Mortgage lenders and credit card issuers use credit scores (94 percent and 90 percent correct respectively). And many other service providers also use these scores — landlords, home insurers, and cell phone companies (73 percent, 71 percent, and 66 percent correct respectively).
• The three main credit bureaus — Experian, Equifax, and TransUnion — collect the information on which credit scores are frequently based (75 percent correct) and that it is very important for consumers to review their credit reports with those agencies to learn if they are accurate. (82 percent correct).
• Consumers have more than one generic credit score (78 percent).
• The following types of information influence scores: missed payments, personal bankruptcy, and high credit card balances (94 percent, 90 percent, and 89 percent correct respectively). And that making all loan payments on time, keeping credit card balances under 25 percent of credit limits, and not opening several credit card accounts at the same time help raise a low score or maintain a high one (97 percent, 85 percent, and 83 percent correct respectively).

[Credit Score Tool: Get your free credit score and report card from Credit.com]

So What’s The Problem?

CFA’s Executive Director Stephen Brobeck said he has “have never seen such improvement from one year to the next,” in the organization’s consumer knowledge surveys. But there was still some basic information about credit scores that many didn’t understand. In particular, consumers didn’t seem to grasp how expensive poor credit scores can be. For example, fewer than one in three were aware that, on a $20,000, 60-month auto loan, a borrower with a low credit score is likely to pay at least $5,000 more than a borrower with a high credit score.

While credit scores don’t take factors like age, marital status or race into account, just over half thought a person’s age (56 percent) and marital status (54 percent) are factors used to calculate credit scores, and 21 percent incorrectly believe that ethnic origin is a factor.

Consumers are also confused about how inquiries affect credit scores. Just 9 percent correctly knew that “multiple inquiries during a 1-2 week window” will not lower scores. In reality, when it comes to FICO scores, recent inquiries within a short period of time for mortgage, auto or student loans don’t affect scores, and going back in time, multiple inquiries for the same type of loan in those categories are treated as a single inquiry. The exact time period varies, depending on which scoring model is used. Similarly, multiple inquiries within a 1-2 week window won’t lower VantageScore scores.

The Smartest Consumers Know Their Scores

Checking one’s credit scores apparently does help cut through the confusion; those who had seen their scores recently were more likely to correctly answer the survey questions. But fewer than half of those surveyed (42 percent) had received at least one of their credit scores during the past year. Of those who did see their scores, the top sources were a website (49 percent) and a mortgage lender (45 percent).

Consumers can test their credit score savvy at CreditScoreQuiz.org and CreditScoreQuiz.org/Espanol.

[Free Resource: Check your credit score and report card for free with Credit.com]

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