Lawmakers Eye Alternative Credit Scoring Shortcut, But It Could Backfire for Millions

A loan can be the key that unlocks the door to a consumer’s dreams, helping them earn a college degree, buy their first home, or even get a new side hustle off the ground. But some people may find it hard to obtain the financing they need to begin charting a course for their future.

Members of the House Financial Services Committee’s Subcommittee on Financial Institutions recently held a hearing — titled “Promoting Access to Credit for Everyday Americans” — that in part explored how alternative data can help U.S. consumers gain credit access.

Building your credit profile can take time. And before lenders extend new credit, they want to see consumers with a history of borrowing money and making repayments of those funds.

That can be a tough pill to swallow for a consumer who needs financing in the near future but lacks a robust credit history.

But just because certain borrowers don’t have the financial background lenders look for doesn’t mean they aren’t able to manage their household budgets.

Lenders may be more inclined to extend credit to consumers who consistently pay their utility bills on time.

Rebecca Kuehn, a partner at the law firm of Hudson Cook that focuses on state and federal commercial and consumer financial services, testified at the hearing.

Kuehn gave a statement on the role of credit reporting in the U.S. and outlined how reliable credit information can be a benefit to lenders and borrowers. She also highlighted that alternative data can play a part in expanding access to credit.

“Responsible use of alternative data — such as consistent utility and telecommunications payment information, as well as cash-flow data derived from bank account activity — can help credit invisible and credit-underserved consumers demonstrate financial reliability and gain access to mainstream credit,” Kuehn said.

She added that, without alternative data sources, certain consumers may continue to face difficulties in accessing the traditional credit system.

Alternative Data May Not Provide a Perfect Solution

Many consumers in the U.S. may be happy that lawmakers and financial experts are discussing ways to level the playing field for access to credit. And the hearing on promoting credit access comes at an especially opportune time for potential borrowers.

The University of Michigan’s Index of Consumer Sentiment in April fell to a record low, Reuters reported. Many people across the country are struggling to keep up with the rising costs of gasoline and other essentials. 

Consumers may be looking for a financial lifeline in the form of a line of credit or personal loan to help carry them through a challenging economic period. But an unimpressive credit background may prevent many would-be borrowers from accessing the loans they need.

Dan Smith, President and CEO of the Consumer Data Industry Association, testified at the hearing that it’s important that U.S. leaders do everything in their power to ensure that people aren’t cut off from access to credit.

“Every American deserves fair, transparent, and affordable access to credit,” Smith said. “That access is not simply a financial convenience. It is the foundation upon which people build their lives. One of the most promising developments in consumer reporting is the growing use of alternative data.”

The University of Michigan’s Index of Consumer Sentiment fell to a record low in April as people contend with rising prices at the gas pump.

Smith said the types of alternative data that can help to form a more accurate view of a person’s financial behavior include information on rental payment history and transactional data. But using alternative data to inform credit decisions may not be a perfect solution.

Chi Chi Wu, Director of Consumer Reporting and Data Advocacy at the National Consumer Law Center, said in written testimony that the idea to include data from rent and utility payments may override privacy protections in certain states. 

In addition, Wu noted that broadening the types of data lenders use in underwriting practices could bring more negative marks to households that are in the midst of financial distress, according to a report on the hearing.

Though using alternative data in lending decisions may offer consumers a path to financial flexibility they couldn’t otherwise access, not all legislators who attended the hearing on the matter are sold on the idea.

“I don’t believe that alternative data is a cure-all for credit inequality,” Rep. Nydia Velazquez (D-NY) said during the hearing, according to PYMNTS.