Researcher warns of risks of using alternative data in lending
What does your SAT score mean for your ability to repay a car loan?
What does your Facebook feed say about your chances of getting a mortgage?
And what does your propensity to snack during car trips mean for your credit score?
The answers: more than you think.
Traditional credit scoring is based on a person’s demonstrated ability to take on debt and repay it. But with the advent of larger data pools and access to more sophisticated modeling programs, lenders and credit agencies are taking greater account of non-financial factors in assessing creditworthiness, particularly those who do not have an extensive credit history. This group tends to include vulnerable populations who are often more susceptible to predatory lending practices.
The problem is that the systems developing these alternative scores can be like a black box, according to Lindsay Sain Jones, a financial regulation researcher at the University of Georgia. With the increase in the amount of personal data available, Jones says it’s time to review the operation and regulation of the US credit scoring system.
“While the use of alternative credit data is touted as a way to expand access to credit – an admirable goal – its use has sometimes resulted in disproportionate negative impacts on protected class borrowers and enabled accurate marketing predatory lending to vulnerable borrowers,” said Jones, an attorney and assistant professor of legal studies at UGA Terry College of Business.
Jones and co-author Janine Hiller of Virginia Tech argue in a new paper that Congress should institute new regulations to prevent alternative credit-reporting services from abusing consumer data in the credit-reporting system. country. Their article, “Who Holds the Score? : Monitoring the Evolution of Consumer Credit Infrastructure,” is available in the April 2022 issue of the American Business Law Journal.
Gaps in credit reporting regulations
New alternative credit scoring systems present challenges not covered by the Fair Credit Reporting Act or the Equal Credit Opportunity Act. These rules give consumers access to data that affects their credit score and prevent discrimination against borrowers based on race or gender. However, they do not directly apply to some alternative credit data and prevent many Americans from accessing the credit system.
Focusing on the intersection of emerging financial technology and regulation, Jones examines how existing regulations, such as those governing credit reporting, impact markets and consumers.
In their recent article, Jones and his co-author argue that further regulation of financial reporting entities – both large credit bureaus and new data collectors – is needed in the same way that financial reporting providers are. gas, electricity and water regulate their services. They argue that participation in the credit system has become as necessary as telephone or electricity.
How the Alternative Credit Score Works
While companies developing alternative credit-reporting services claim their products allow underserved populations to access these vital services, the opaque nature of their operations makes them ripe for predatory lending practices, Jones argues.
With the new products, borrowers don’t know what information is used to calculate the score, so they can’t dispute incorrect information.
Some credit reporting agencies offer consumers a “credit boost” in exchange for access to their utility or rental payment histories. But there are few regulations on what agencies can do with that information and how long they can retain it, Jones said.
“So as a candidate, you’ve technically given them permission to do it, but you’re in a vulnerable position,” she said. “Your loan has been declined. You still need the loan. So you give them all your data and you may earn as little as a single point on your credit score or not at all. You may or may not have better chances of getting your loan, and what they do with that data is all in the fine print.
Other times, lenders extract information from public records or social media accounts to create a credit profile without the knowledge of borrowers.
“There’s also fringe alternative data that companies collect without your permission,” Jones said. “Some companies specialize in pulling data from online sources — your LinkedIn and Facebook profiles — and feeding their credit model.”
This can include purchase history, where and when a person applied for a loan, student history, employment history, and social media information.
In this case, borrowers do not know what criteria they are being assessed on and have no way to dispute inaccurate information.
“There is no appeal process,” she said. “With your traditional credit score, you can appeal inaccurate information. Suppose you had a credit card with Bank of America and your report says you were charged. If you didn’t, there is a process for appealing this error put in place by the Fair Credit Reporting Act and they should address your concerns.
There’s no way to appeal if the lender doesn’t like how often you travel or buy clothes, she said.
Protect vulnerable consumers
Jones and his co-author also worry that many of the lifestyle data points that lenders correlate with creditworthiness may be related to race, gender, age, socioeconomic status, to a person’s zip code or where they attended college. It is almost impossible to successfully challenge this type of disparate impact within the framework of the ECOA.
One agency pulled information on how often people pay for gas at the pump versus inside the store. People who paid at the pump were considered more creditworthy.
“There are all sorts of factors that can be correlated to creditworthiness, but that doesn’t mean they should be used,” Jones said.
Jones argues there is a need to expand access to lending markets, but access should come with the same protections that apply to traditional credit data.
“Where do you draw that line?” she says. “Are you opening up new credit opportunities for people, or are you exploiting the vulnerable?”