The Future of Credit Underwriting with Alternative Data

November 8, 2021

The US has the most developed and competitive consumer credit market in the world. Yet, there are 50 million Americans that are considered to be “credit invisible”. Credit activity that is not reported to the credit bureau and therefore, not included in the consumer's credit score, is considered to be “invisible”. Additionally, 53% of small businesses reported that they were not able to receive the financing that they initially applied for. Due to this rising issue, the credit underwriting industry is in need of a change to expand access to credit as well as provide favorable borrowing terms. Welcome, alternative data.

⅓ of borrowers do not have access to credit because of the traditional underwriting system. Traditional credit scoring utilizes few sources and does not tend to give a full financial picture of the consumer applying for the financing. Alternative data provides a full view of the consumer’s financial picture in utilizing different sources than the traditional system. This allows institutions to increase their financing volume and customer base, while ultimately decreasing the risk of human error during the underwriting process. The data analyzed can include the consumer’s transaction history, location, education and occupancy information, social media use, in addition to overall mobile activities.

Credit invisibility does not necessarily mean that consumers have never accessed financing or have no credit at all, but more so refers to the daily activities of the consumer not being reported by traditional standards. Landlord reporting of on-time utility payments to the credit bureau varies from landlord to landlord, thus not dependable for a credit building activity. On top of that, short-term loans of less than 3 months do not get reported to the credit bureaus. This can create issues for consumers that are not informed of credit building activities as well as have trouble accessing credit, thus limited opportunity to build their credit for future financing opportunities.

Traditional credit scoring utilizes payment history, credit utilization, credit history, types of credit, and new credit. The bulk of the credit score rests on payment history and credit utilization; with payment history at 35% and credit utilization at 30% weighting. Consumer’s that have not had access to credit prior, or participate in payment activities that are not reported, will struggle to increase their credit score. This is where alternative data can truly provide value and increased opportunities among the global economy.

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Companies such as Oportun are making financial opportunities for those that are underserved in the market. Oportun is on a mission to target those that are credit invisible by leveraging alternative data to make financing decisions. Square and Paypal are among other companies that are disrupting the traditional credit system by analyzing transaction histories (cash flow underwriting) of merchants when offering cash advance options.

Alternative data provides the opportunity for institutions to disrupt traditional underwriting models. Additionally, it can lead to increased lending volume, lower interest rates, and improve accuracy of a good loan versus a bad loan. In a recent report by FICO, it was found that alternative data proved to be as accurate as traditional methods during the lending process. The report also found that due to the use of alternative data and the increased eligibility for financing, consumers are seeing an increase in their credit score to 620 and beyond. Lastly, it has been found that bringing access to financing for  “unbanked” consumers and small businesses could earn approximately $380 Billion in new revenues for banks across the globe.

The use of alternative data has the potential to enhance the access and affordability of credit, while making the traditional credit system more inclusive. Additionally, lenders have the opportunity for increased revenue potential due to the acceptance of an untapped market due to applicants previously not being serviceable for financing. The entire economy can benefit from financial inclusion as this will not only allow for individuals to experience further financial opportunities, but it will also allow small businesses across the country access to capital to use toward scaling and growing their operations.

ModernTax allows institutions to gain access to their clients IRS tax transcripts in minutes with their clients permission. We offer a no-code or API solution that delivers the wage & income, return, record of account, and balance transcripts. This allows institutions to analyze a client’s full financial picture, as well visibility into their historical financial background.

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