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The Invisibility Cloak of Traditional Credit Scores

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How Alternative Credit Data Brings the ‘Credit Invisible’ into View

By Patrick Reemts

Purchasing a home was once viewed as a rite of passage for young adults, similar to getting a driver’s license or graduating college.

As millennials—those ages 18 to 29—approach the age when home buying traditionally happens, few are actually entering the mortgage market, not for lack of interest or effort, however. This generation faces a variety of challenges, which may impact the future of the housing market.

Millennial Credit and Behavior Trends

According to a recent report from the Consumer Financial Protection Bureau, “Data Point: Credit Invisibles,” young adults have a high incidence of being “credit invisible,” meaning their credit histories render them unscorable based on the traditional credit scoring methods. Traditional credit scores, like FICO credit scores, are calculated based on mortgage, credit card, auto loan, and other installment loan payment histories.

Given that millennials have not had the opportunity to develop a “traditional” credit history, in part due to the recent recession and tightening of lending policies (Credit CARD Act of 2009), this demographic often does not qualify for financing with traditional credit scoring practices. Data released by the Federal Reserve Board of New York shows more than two-thirds of the under-30 age group have credit scores under 681. Almost 40 percent of this age group have scores less than 621, while many others do not have credit scores at all.

Since credit bureau scores weigh heavily in the credit decisioning process, millennials are potentially being barred from the mortgage market due to the widespread industry use of traditional credit scoring models, which render them ”credit invisible,” making it extremely challenging to secure a mortgage.

Given the number of credit invisibles, it’s clear lenders need to rely on more than just traditional credit data sources.

Alternative credit data sources include insights from the wireless, banking, peer-to-peer lending, checking and savings, and subprime markets, along with address change histories, to deliver a precise and unique view of a consumer’s credit risk and worthiness.

However, the mortgage industry has been the slowest to adopt alternative credit data because even with programs like HUD, which has a mission to “create quality affordable homes for all,” mortgage lenders are reluctant to adopt new risk management tools due to heavy government oversight.

According to ID Analytics’ recent whitepaper, “Millennials: High Risk or Untapped Opportunity?” millennials were found to engage most with financial products and services that are the most available to them, especially ones that have not been affected by the Credit CARD Act of 2009.

Dispelling the Myths Around Millennials and Credit

ID Analytics’ study reveals millennials are denied at a much higher rate than others, despite outperforming other demographics within the same credit score range. For example, baby boomers and generation X are two to three times more likely than millennials to become delinquent in making a payment by 12 months or more.

Across the financial marketplace, there is a misconception that millennials do not want to establish or use credit. However, the study uncovered that this generation is, in fact, applying for credit but being denied based on new challenges, standards and policies.

This lack of information reflecting their healthy financial habits is the biggest barrier to entry for millennials looking to jump into the mortgage market.

When taking a comprehensive look at the generation, it is difficult to deny that millennials are facing unprecedented financial challenges that previous generations did not encounter.

What This Means for the Housing Market

Millennials want to establish credit and buy homes, but they are being overlooked because of traditional data sources. Given that traditional scoring does not accurately capture this group’s credit worthiness and risk, there is an urgent need for a solution that welcomes the 75.3 million millennials in the United States to the financial marketplace.

The solution is to find a way to assess credit worthiness that provides insights into millennial purchasing behavior, rather than relying solely on traditional metrics.

Using a score that includes alternative data, such as the individual’s credit behavior in wireless, banking, peer-to-peer lending, checking and savings and the subprime markets, will be more telling for the industries where millennials are seeking to establish credit relationships.

Editor's note: This select print feature appears in the December 2015 edition of MReport magazine, available now.

About Author: Patrick Reemts

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Patrick Reemts is the VP of credit risk solutions for ID Analytics. He has more than 15 years’ experience in the consumer lending space. Previously, at Discover Financial Services, he launched the first-ever credit bureau trigger prescreen program with Experian. Reemts also pioneered the use of FICO’s Strategy-Ware for making large decision-tree and score-based credit decisions for HSBC’s card division.
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