Trying to build credit or facing credit “invisibility”? Your bank may be able to provide a path to build credit with new changes and processes.
It’s the ultimate Catch-22 for anyone first seeking credit: To get it, you need a credit score. And without credit, you don’t have a credit score.
Welcome to the frustrating world of the “credit-invisible.” Which is just another way of saying that when a consumer has little or no credit to their name, conventional credit scoring formulas like FICO and VantageScore can’t assign a credit score.
With an estimated 45 million to 65 million U.S. adults invisible to conventional scoring formulas, it’s a much bigger group than you might imagine, says Grovetta Gardineer, senior deputy comptroller for bank supervision policy at the Office of the Comptroller of the Currency – the federal department that regulates national banks and federal savings associations.
“That’s a huge number,” she says. “And if you have a thin file or no file, then the opportunity to amass anything with regard to credit is not an option for you.”
Who is credit-invisible?
Consumers who are invisible to credit scoring formulas include everyone from new grads and debt-wary millennials to established families and budget-savvy seniors living on cash. Minority and immigrant communities are disproportionately affected, says Gardineer.
These days, being excluded from credit is more than not having convenient payment options and access to online shopping. Credit scores are routinely used to decide if consumers get car loans, apartments or bank accounts and frequently factor into the cost of insurance.
“Credit is king,” Gardineer says. It’s a crucial tool in “building a firm economic foundation for your family – and it’s also the path to generational wealth.”
Repairing the ‘broken’ credit system
In the summer of 2020, as the racial justice movement gripped the nation, “there was a steady drumbeat that the system is broken,” says Gardineer. So the OCC, which regulates many of the nation’s largest banks, decided to approach the problem from a financial angle.
It convened a meeting of banks and community groups and proposed taking a new look at a very traditional idea: If a consumer seeking credit doesn’t have enough credit history to generate a credit score, how about looking at their deposit and cash flow information instead? The OCC also added a 21st century twist: What if banks shared that account information so that consumers could shop their credit options – just as they could if they had a traditional credit score?
Gardineer expects to see some banks roll out their programs and products before the end of the year, while others will launch in 2022. A few of the participating banks include JPMorgan Chase, U.S. Bank and Wells Fargo.
Early Warning Services, which partners with many banks on the Zelle money-transfer network, is in place to handle the sharing of account data, says Gardineer. And banks are ramping up to create their own versions of cash-flow credit evaluation and products.
“There will be a lot of consumers who will be helped by this,” says Francis Creighton, president and CEO of the Credit Data Industry Association – the industry group for credit bureaus.
While some of the credit bureaus have been incorporating alternative data, this would happen as part of a bank’s own lending process, he says. It’s “a very targeted initiative.”
How, exactly, lenders use account data to substitute for credit scores is going to vary from bank to bank. “Each one of the institutions that will do this is building their own model,” says Gardineer. “So there is not a one-size-fits-all here.”
She imagines that the concept will be used primarily for underwriting credit cards, personal loans and possibly auto lending.
If consumers can use the financial products they already have to get credit and build a good credit history, they can use that good credit to secure apartments, home loans and business loans – as well as cut the cost of services that often use credit scores, like insurance and cellphones.
The OCC also has included a host of minority and community groups in the discussions, including the NAACP, the National Urban League, the National Asian American Coalition, the U.S. Hispanic Chamber of Commerce and Operation HOPE.
As the project moves from theoretical to actual, the OCC hopes that groups also will help their members find credit and lending programs that are effective and well-run – spreading the word and the wealth.
Everything old is new again
The idea of looking at a person’s cash flow and bank balance to assess creditworthiness is nothing new, says Ira Rheingold, executive director of the National Association of Consumer Advocates . In fact, it was common prior to the widespread adoption of credit scores in the 1980s and 1990s.
Sometimes called “residual income lending” or “cash-flow lending,” it’s where lenders “measure people’s ability to repay credit by looking at how much cash is coming in and how they pay their bills,” he says.
“Right now in America, it’s really expensive to be poor,” Rheingold says. “And we need to stop that.” Consumers need access to affordable bank accounts and credit products, he adds.
The idea of a regulator getting behind the move is “powerful persuasion” to banks and lenders, says Rheingold.
Still, some consumer advocates have concerns, especially over the yet-to-be-revealed fine print.
See related: What is a thin credit file, and how can you build it up?
Consent and security
The plan is “a more individualized assessment of people,” says Rheingold. “It will help people who are not visible under the current credit reporting regime.”
But for consumer protection, Rheingold also wants to see “a system in place where that account information remains as private as possible.”
Data should be available “only to the consumer and their representative,” he adds.
Advocates also want consumers to be aware of when and at what point a lender would be looking at their deposit information.
This project uses “one of the more promising forms of alternative data” for consumers who don’t have a credit score, says Chi Chi Wu, a staff attorney with the National Consumer Law Center .
“The thing about this particular pilot project we would like to see is consumer permissioning,” she says. “Other forms [of alternative data] have required consumers to opt in. One of principal problems of the credit reporting system is that consumers have no control.”
Another concern: Will lenders scale up, incorporate the initiative into their lending practices, and remain committed long-term to using deposit data for consumers who don’t have credit scores?
“Time will tell,” Rheingold says. “It’s a good idea. It’s a very good idea. And it could have a very positive impact on consumers.”
Fewer obstacles, more access
Gardineer realizes that using bank account information in place of credit scores won’t make everyone visible to credit scoring formulas – especially those who don’t have bank accounts. “And I believe that we will get to a solution that will reach that population,” she says.
In the meantime, she says, using deposit information will increase the number of consumers who can access credit – and that’s a good start toward removing the financial obstacles hampering consumers currently invisible to credit scoring models.
There’s also been a positive response in the financial community.
“One really pleasant surprise is the number of entities and individuals and fintech companies who, when they heard about this, wanted to be part of it,” says Gardineer.
“We started with about 10 entities, individuals and fintech companies. By the end of last year, that has ballooned to about 70. It’s heartwarming to know that this many entities want to come in on the solution.”
How to build credit without a credit score
Looking to enter the world of credit without a credit score? A few of the options consumers use include:
Secured credit cards: The applicant “secures” the credit card with a deposit roughly equal to the credit line. The issuer holds that money as long as the card account is open.
But the deposit doesn’t cover purchases, payments, interest or fees. The idea is that after six months to a year of reporting positive account information to the credit bureaus, the consumer will have enough credit history to generate a credit score.
Not all secured cards are consumer friendly. Some charge a lot of fees or higher-than-average interest rates. Some check credit scores before issuing a card – meaning they’re not an option for people with no credit score.
Also, it’s not enough for a card to say it reports to the credit bureaus. To build credit, you need a card that reports all account information to all three bureaus every month.
Small personal loans: Consumers go to their own banks or credit unions for a small loan to establish credit. Terms, products and rates vary widely by institution. Not all institutions offer them, and some lenders check credit scores – which means the option might not be available for consumers who are invisible to credit scoring formulas. A version of this – sometimes called a “passbook loan” – secures the loan with money the consumer has on deposit at the institution. Similar to a secured card, consumers can’t access those funds until they’ve repaid the loan.
Experian Boost: This is a free service. After you sign up for Experian Boost, the credit bureau will scan your bank account for recurring monthly payments (think phone bills, utility bills, cable bills), and add those lines to your Experian credit history.
It only notes on-time payments, and the aim is to “boost” the score by showing responsible financial behavior. But it will only impact your Experian credit report and scores that use that report — which is one of three major credit histories that lenders can use. And if you don’t have a credit file, the additional information will not be enough to generate a credit score, according to an Experian spokesperson.
Petal: Petal’s unsecured credit cards – the Petal 1 “No Annual Fee” Visa® Credit Card and the Petal 2 “Cash Back, No Fees” Visa® Credit Card – were developed for consumers who are invisible to traditional scoring formulas. The cards use an applicant’s income, cash flow and past financial behavior to gauge creditworthiness. Issued through FDIC-member WebBank and carrying the Visa brand, they have no annual fee.
Petal also reports account information monthly to all three credit bureaus. For Petal 1, the variable APR ranges from 20.24% to 29.74%, depending on the consumer’s financial history. For Petal 2, the variable APR range is 13.24% to 27.24%.