Alternative credit scoring involves electronic data collection on the payment behaviour of consumers. This can include information on regular expenses such as mobile bills, internet, and also utility bills. It’s growing in popularity, making it a boon for borrowers who have low scores on the traditional credit scoring system.
What is alternative credit scoring?
Credit scoring had been very rigid till recently, as lenders and credit bureaus referred solely to an applicant's borrowing history while ascertaining creditworthiness. This worked to the disadvantage of borrowers with zero credit history or low credit scores. These borrowers found it difficult to qualify for loans, and even when qualified they had to pay higher interest rates on loans.
With the advent of alternative credit scores, this issue is slowly being addressed through the usage of current, relatable and easily available data on applicants. It is slated to help lenders ascertain a borrower’s creditworthiness through their digital footprint.
Alternative credit scoring is based on 3 important factors:
While focusing on factors other than CIBIL™ scores, credit rating agencies use an applicant’s social and digital data for ascertaining the above-mentioned factors. These include the applicant’s ability and willingness to pay back the loan and whether they are financially stable to make complete repayment of borrowings.
How does alternative credit scoring work?
To arrive at an alternative credit score, credit rating agencies use tools that are based on the below-mentioned data sets. This is mostly done through AI and ML-powered algorithms.
• Utility bill payments
• Bank account details
• Telecom payments
• Rental and lease payments
The payment patterns of these bills show the applicant’s intent and ability to make the payments in a disciplined manner. This also reflects a person’s creditworthiness in a transparent way as compared to a traditional credit report.
This is mainly because the credit ratings as per traditional credit reports are usually valid for up to 2-3 years. During this time, an applicant’s financial situation may have changed positively or negatively.
Even if an individual has been maintaining a good credit score, chances are that he/she might have trouble paying the bills currently, due to a job loss, etc. Even if this were the case, such individuals might get their loan applications approved, which makes it risky for the lender.
On the other hand, a person who doesn’t have a credit score but can and is willing to pay all bills on time, may not get a loan due to lack of a credit score.
What are the benefits of alternative credit scoring?
Alternative credit scoring helps people who find it difficult to enter into the credit system, by allowing them easy access to loans and the overall credit system. It provides them with an opportunity to start rebuilding their credit scores.
For lenders, alternative credit scoring allows access to those sections of the population who are often denied loans or credit. With the help of alternative credit scores, lenders can extend credit to this group of people. This mechanism also brings down the risk of lending for lenders and lowers the interest rates for borrowers depending on alternate credit scores. It’s a win-win situation for both lenders and borrowers.
Here are some of the top benefits of this concept:
Alternative credit scoring focuses on current parameters rather than historical data. This makes it easier for applicants with no credit score since their reports can still be generated as per their current financial discipline and credit habits. The scoring also takes into consideration the social interactions of applicants to get a better view of their ability and willingness to pay back the money borrowed. Thus, alternative credit scoring is a better technique with regard to accuracy when compared to traditional scoring methods.
Increased market reach
Due to the absence of credit scores, a large section of the unbanked population and people who have no prior credit record are unable to apply for loans. In case they do, chances are that their loan applications do not get sanctioned since lenders avoid taking on more risk by lending to such applicants. Alternative credit scoring has created a marketplace for such applicants and lenders who wish to lend to such target group as per their payment discipline and alternative credit score. This also provides applicants with more credit options and competitive interest rates.
Enhanced customer experience
With automated alternative credit scoring techniques, lenders can reduce loan origination costs and pass on this benefit through lower interest rates to applicants. With automated processes for underwriting loans, lenders can minimise bias and errors that are otherwise common in manual underwriting.
Improved deals for existing borrowers
Existing borrowers who have taken loans based on limited credit information may be subjected to higher interest rates. This is mainly because such borrowers are considered risky by lenders due to limited credit history/data. With alternative credit scoring through real-time data that is based on their behaviour on purchases, bill payments, banking transactions, etc, existing borrowers can avail refinancing of their loans at reduced interest rates. This not only helps borrowers but also lenders since they can receive additional business through client retention.
Of late, credit rating agencies have started partnering up with fintech firms to gather valuable and reliable data for better credit assessments that provide accurate results.
Lenders are slowly but surely gravitating towards credit rating tools that give the best and most accurate results. While this is expected to strengthen the lending industry and cover otherwise unbanked masses, it is set to heighten the importance of alternative credit scoring.
- What is alternative credit scoring?
Alternative credit scoring takes into account an individual or borrower’s present financial situation and willingness to repay borrowings instead of relying on historical credit reports.
- How do I build alternative credit?
One can build an alternative credit score by focusing on positive spending and repayment habits especially with online transactions. These behaviour patterns are picked by agencies to generate an alternative credit score.
- Why are online lenders focusing on alternative credit scoring?
Online lenders are focusing on alternative credit scoring since people are increasingly making purchases on various online platforms. Their spending, borrowing, and repayment habits can be easily gauged through online transactions. This makes it easier for credit agencies to estimate an individual’s alternative credit score.
- Is credit scenario changing across the world?
The credit scenario is slowly changing across the globe as lenders and credit bureaus are focusing on borrower’s present financial and credit position as compared to solely relying on historical credit data.
- What are the benefits of alternative credit scoring?
Alternative credit scoring benefits borrowers as it opens credit channels for them irrespective of their past credit behaviour or non-existing credit history. It also benefits lenders by allowing access to an untapped market of borrowers who have no credit history.