Consumers, credit bureaus grapple with 'thin file' problem
Companies rise to help kick start credit scores, meet limited welcome
By Martin Merzer | Published: October 31, 2008
Generally speaking, thin is good. Your cell phone, your laptop, your ... physique. Thin, thin, thin. Good, good, good.
But not so much when it comes to your credit history.
There, thin definitely is not good. If you have what the industry calls a "thin-file" credit history -- or worse, a "no-file" credit history -- you will find it virtually impossible to qualify for an attractively featured credit card or a competitively priced mortgage.
Of the nation's 220 million adults, 33 million are categorized by credit rating agencies as thin-files and 22 million as no-files, according to Craig Watts, a spokesman for Fair Isaac Corp., a leading provider of credit analysis tools. That population tends to include new immigrants, the recently divorced or widowed, graduating students and a disproportionate number of minorities - the very people most in need of a good start with good credit.
"It's a genuine issue," said Watts, whose company created the widely used FICO credit score, a crucial indicator of an applicant's creditworthiness. "In American culture, thin is usually a winner, but not when it comes to credit histories."
"In American culture, thin is usually a winner," he says, "but not when it comes to credit histories."
Nontraditional credit scores rise
Now, for the brighter side: Some remedies are available, including an innovative "nontraditional" route that verifies consumers' rent, utility and other payment histories and produces a version of the all-important "credit" score, though previous credit isn't really part of the equation.
The concept recently won qualified endorsement from the federal government and can aid some mortgage applicants, but it is not yet widely embraced by credit card companies.
A leading proponent of nontraditional "credit" verifications is a firm called Payment Reporting Builds Credit. It calls itself "the first credit bureau to give consumers and small businesses a way to build a credit file to demonstrate creditworthiness without the need to go into debt."
We developed this because we thought the existing system was very unfair to consumers who haven't gone into debt but are creditworthy.
|-- Michael Nathans
Michael Nathans, founder and president of PRBC, which originally stood for Pay Rent, Build Credit, says that more than 600,000 Americans are building financial histories at his company, one bill payment at a time. Other companies in the field include First American Credco and LexisNexis, which assemble similar data, though in different ways.
"We developed this because we thought the existing system was very unfair to consumers who haven't gone into debt but are creditworthy," says Nathan, who prefers to call his program a "bill-payment system" rather than a "nontraditional system."
"There's nothing nontraditional about paying a rent bill or a utility bill," he says.
Deal with RushCard
Earlier this month, PRBC aligned with the Prepaid Visa RushCard, a debit card that now offers to report users' transactions to PRBC. "Over time," according to a RushCard statement, PRBC "can use a member's transaction history to create a positive credit file that lenders can use to determine creditworthiness."
Well, maybe. Representatives of credit counseling agencies, traditional credit verification firms and major lenders are plainly dismissive when it comes to the credit-building value of debit cards.
"Debit cards haven't yet proven their contribution to a credit-risk prediction," says Watts, the Fair Isaac spokesman. "The reason is they aren't really credit transactions. You've already put the money down to fund the debit card. It's just not the same thing."
A spokesman for Bank of America says the company's credit card operation simply won't consider data from a nontraditional verification firm.
...(I)f credit history is not reported to one of the major credit bureaus, we typically don't rely on it.
|-- Jim Pierpoint
Bank of America spokesman
"In the case of a thin file, we will contact the customer directly to build a credit profile," says the bank's Jim Pierpoint. "Beyond that, if credit history is not reported to one of the major credit bureaus, we typically don't rely on it."
Traditional credit scoring system wary
At the same time, however, Fair Isaac and some credit verification firms and lenders are tip-toeing into the field -- using rent and utility-bill data as a component of their formulas, particularly when it comes to mortgage approvals. Many also acknowledge that bill-payment records could supplement a traditional credit report or contribute to a consumer's wider and more conventional strategy to build a functional credit score.
More on that in a moment, but first it must be remembered that any effort to become creditworthy can take a while to gain traction, and consumers must exercise caution throughout the process -- both in choosing the route they take and in using the credit they eventually secure.
"Everyone should strive to build a good credit history, and responsible use of all forms of credit is the best way to build that history," says David Jones, president of the Association of Independent Consumer Credit Counseling Agencies, which represents 37 nonprofit credit counseling companies, including many with national reach.
"But you should never overextend yourself," he says. "That's very important."
How credit scoring works
To navigate the system, Jones and others say, you need to understand the system, and that pretty much begins and ends with credit scores.
Like it or not, the scores produced by the Big Three credit rating agencies -- Equifax, Experian and TransUnion, all of which use equations and algorithms created by Fair Isaac -- are a fact of life. The Big Three also have their own version of a credit score, a FICO alternative called VantageScore that takes a special interest in people without hefty credit histories.
"Thin files are one of the reasons why VantageScore was created," a company spokesman said.
Interestingly, VantageScore has found that when no-file applicants are carefully analyzed, 26.5 percent receive scores that render them creditworthy. More than 15 percent of thin-file applicants also qualify for credit.
"This is a way to bring more credit to more people," the spokesman said.
These credit scores are employed by credit card companies, mortgage lenders, auto dealers and many other entities to assess how likely you are to repay your debts -- and to determine the cost of your loans. The better the score, the lower your interest rate and, when it comes to credit cards, the higher your credit limit.
Obviously, it is very much in your interest to have a decent credit score. The generally accepted scale ranges from 300 ("forgetaboutit") to 850 ("Are you sure that's all you'll need? Don't you want to borrow more?")
But it's nearly impossible to get a decent credit score -- and sometimes, any credit score -- without a significant history of credit and a really significant history of repaying that credit.
It's the Catch-22 quandary of financial planning: You need a good credit score to get robust credit, but without robust credit, it's hard to get a good credit score.
So how do you begin? The two main paths to a respectable credit score, both of which require patience and diligence, are:
- The traditional path: Start small. Gas station and department store credit cards tend to have lower qualification standards and credit limits than top-tier general purpose credit cards. Also, if you have a student loan or any other financial obligation, make the payments on time -- every time.Doing all of this can help you establish a good credit record and form the foundation for more and deeper credit down the road. "Whatever contracts you have, you honor," Jones says. "That's the most important thing you can do."
- The nontraditional path: PRBC and the other new players in the industry, recognizing that many thin-file and no-file Americans are worthy of credit but unable to obtain it, are working to verify nontraditional data about the spending habits of the uncredited, so to speak. That could include rent, electricity, cell phone, cable TV payments and even day care expenses.
At the moment, PRBC's Nathan acknowledges that this pathway offers little practical benefit to credit card applicants, though he expects card issuers to become more accepting of bill-payment histories in coming years.
The news is better for mortgage applicants: Major credit rating agencies and the mortgage lenders they serve are beginning to incorporate this information into their credit scores and home-loan underwriting formulas.
And, in a little-known development, federal officials are taking steps to assist.
Help on mortgages
For one thing, federal regulations require mortgage lenders to consider any information submitted by applicants -- including bill-payment histories, even if substantiated only by paper receipts .
At the same time, the U.S. Department of Housing and Urban Development is starting a pilot program that will evaluate borrowers who do not have a traditional credit history and credit score.
Earlier this year, HUD also issued a set of rules under which mortgage lenders should consider rent, utility and other nontraditional credit histories.
Although the rules technically apply only to mortgages insured by the Federal Housing Administration, such advisories tend to establish a wider precedent, and this one was viewed by many advocates of nontraditional credit scores as a major breakthrough.
We try to be on the cutting edge of new ideas and regulations that can make the industry better ...
|-- Lemar Wooley
Spokesman, U.S. Department of Housing and Urban Development
"We try to be on the cutting edge of new ideas and regulations that can make the industry better, and the industry does take its cue from us," says Lemar Wooley, a HUD spokesman in Washington.
How one alternative works
Even a tentative endorsement of nontraditional credit references came as welcome news to PRBC and the other companies that specialize in bill-payment verifications.
In the case of PRBC, consumers create their own accounts online, listing their rent payments, utility accounts and so on. After building a history (Nathan recommends at least 12 months of bill payments), a consumer can ask PRBC to verify the accounts. The charge is $20 for a rental verification, $15 for any other type of bill. The typical customer carries four "lines" of payments and pays about $65 for the service, Nathan says.
Again, this pathway offers little assistance to people seeking quick access to top-tier credit cards. For them and for most thin-file and no-file Americans, the most common advice is the most time-honored advice.
"My grandfather was a banker and he coached me," says Fair Isaac's Watts. "Start out small. Go to the bank that has your checking account and ask for a small loan. Pay it back on time. Try to get a gasoline or department store card. Then, go for general purpose credit cards.
"Build it all up slowly," Watts says, "and you'll be fine."
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