There is a big problem with the U.S. lending system. The people who can least afford large debt payments face the highest borrowing costs. And while these people are clearly the most financially vulnerable, they are often the most credit responsible. They must be if they often have to pay back loans at 26 percent or even 100 percent rates.
Many of these financially vulnerable consumers fall under the “credit invisible” or “credit unscorable” categories. The Consumer Financial Protection Bureau defines these individuals as consumers with no credit history with a nationwide consumer reporting agency or not enough current credit history to produce a credit score. One out of 10 U.S. adults are credit invisible or credit unscorable. Think of the millions of Californians who fall into these categories.
Thankfully, the California Legislature is taking some good first steps to help those Californians. This year, the Safe Consumer Lending Act (Assembly Bill 1109) was introduced to cap the annual percentage rate at 24 percent for high-cost installment consumer loans of $2,500 to $10,000. This bill presents a great opportunity to highlight and address a serious issue in the consumer credit industry. While this legislation is a good start, it’s time to change the playing field by which a person’s financial and credit rating is measured to better reflect the realities of the modern U.S. economy.
As the CEO of a financial services company, I have a fundamentally different perspective on consumer credit than those businesses in the world of payday loans, subprime credit and predatory lending products. More change needs to happen, and not just in legislation and consumer outreach. There needs to be significant innovation in the financial industry. This is an opportunity for entrepreneurs and companies to focus on innovative business models or services that focus on credit building, from which many Californians would greatly benefit. With the vast amount of “big data” virtually at our fingertips, there should be opportunity to gather richer more relevant information to better understand an individual’s credit worthiness through their behaviors.
Algorithms and data used in today’s credit score calculation are not reflective of modern economic life. Alternative data such as rent, utilities, child support, cash transactions, work salary/seniority, type of housing and remittance history should be adopted into credit scoring models. Take for instance, rent. For 100 million people in the country, rent is their major monthly expense. In the post 2008 economy where an increasing number of households are renter vs. owner occupied, rent payment history should be an important part of credit rating algorithms. This would provide a step in the right direction for the credit invisible or credit unscorable to establish a score for the first time or improving an existing rating based on their positive and documented financial behavior. This would result in increased access to appropriate credit products and reduce the cost of borrowing, enabling them to engage in important everyday activities that many take for granted.
That is the kind of equal playing field in the world of credit that I think we can all support.