Written by: Erica Sandberg
Edited by: Lillian Guevara-Castro
Reviewed by: Adam West
It has taken decades for credit reporting to change with the times, but it’s finally here. Analyzing a prospective borrower’s credit risk based on their cash flow and other financial factors is not just helpful to millions of individuals; it throws open the doors for lenders.
Cash flow-based credit scores are now here. They will not replace the established credit rating systems because credit reporting and the scores that are derived from those files are still valid, but cash flow-based credit scores will act as an important adjunct. In some cases, they will be a standalone score.
This is excellent news for all concerned.
Frustrated Consumers Have Fallen Through the Cracks
From an individual’s perspective, building credit quickly can be an extremely frustrating process. Many know they are good risks but don’t have the credit scores to prove it.
Over these many years, I have heard plenty of lamentations from people who would like to borrow money but find themselves in a quandary because they don’t have the scores that prove they’re a good risk.
They often fall into one (and sometimes many) of the following situations:
- I have lots of money in the bank.
- I just got a great job.
- I’ve held my job for a long time; I just prefer to use my debit card and cash for everything.
- I pay all my bills on time.
- I’m new to this country.
- I’m a young adult.
Although everyone can take steps to develop their credit, that can take many months, if not years. Such a delay leaves millions of consumers out of the system.
Closing the Credit Gap With Cash Flow
Traditional credit scores, including FICO and VantageScore take the information that appears on consumer credit reports — TransUnion, Equifax, and Experian — then input the data into algorithms to determine credit risk.
In general, these scores are excellent. They can predict how a person might use a credit card or repay a loan based on their past behavior with these products.
They do not, however, input any information that is not on these credit reports. For example, regular paychecks, cash in checking, savings, and investment accounts all fall outside the credit-scoring algorithms because they are not included in a credit report.
The information is usually requested on an application, though, because it is relevant to the lender.
Consumer reports that offer cash flow credit scores, on the other hand, do assess a wide variety of banking transactions, offering a far fuller economic picture.
“Scores that incorporate cash flow data allow borrowers to provide lenders a more holistic, real-time view of their financial situation,” says Jonathan Gurwitz, head of credit partnerships at Plaid, which last year launched Plaid Check, the company’s consumer reporting agency.
Gurwitz continued, “This helps lenders improve credit risk management and expand access to more affordable credit.”
By adding cash flow data into the underwriting process, lenders can navigate market volatility, evolving consumer behavior, and much more. Rather than tightening during economic uncertainty, cash flow data can empower lenders to improve decision accuracy with real-time transaction data from a consumer’s bank account.
Why Not Both?
Indeed, both credit scores and cash flow scores are useful to lenders. They are also positive for the consumer. If you don’t have one, you may have the other. If you have both, that’s even better.
“When traditional credit scores are augmented with cash flow data, lenders are in a position to provide a more efficient customer experience, and ultimately increase profitability by serving more potential borrowers and better managing risk,” Gurwitz said.
“Cash flow data can complement traditional credit data,” Gurwitz continued. “When lenders can access a borrower’s real-time transaction data across income, expenses, and account balances, they gain insights that are central in assessing a borrower’s ability to pay.”
Services such as Plaid allow banks and credit bureaus to share cash flow data, leading to a more accurate financial picture.
It all starts with open banking, which allows third-party financial service providers to access a person’s banking data (with their permission).
Open banking enables companies like Plaid to provide a seamless experience, ensuring consumers are sharing the most current information for qualification and giving borrowers the most current information for assessment.
More Accurately Assessing Consumers Who Deserve a Chance
Everyone wants to be fairly assessed, based on the reality of their circumstances. That goes for how they have handled credit products in the recent and distant past but also their financial situation in the present.
Cash flow scores can come to the rescue for new borrowers as well as credit-shy consumers and those who have damaged credit and are working on rebuilding it.
“Because credit scores can’t provide a complete financial picture of a borrowers’ financial health, millions of consumers are underserved and lenders are exposed to unforeseen risk,” said Gurwitz. “Cash flow underwriting gives consumers an opportunity to show a live, ongoing view of their financial health.”
Gurwitz continued, “This creates inclusion for millions of non-traditional borrowers like gig workers, freelancers, and people new to credit in general.
So, to everyone asking why they can’t be judged on how much money they earn or how much they have in the bank rather than their borrowing habits — which may or may not exist — now there is an answer. They can.
