Since the 1950s, credit scores have been the gold standard for lenders. However, credit scores alone don’t paint the full picture of a loan applicant’s finances because they don't consider factors like income or spending habits. As a result, both consumers and lenders are missing out.
Incorporating alternative credit data, such as on-time rental payments and monthly utility payments, can reveal a more holistic picture of a borrower’s finances. This “alternative data” to traditional credit scores can increase access to loans at a lower interest rate. It can also expand credit access to those who lack the financial history and increase lenders' customer base.
In this article, we’ll examine how alternative credit data is used, the different types available, and the business and social opportunities it creates.
Alternative credit data: What is it and how is it used?
Alternative credit data is financial information not typically reported to the three main credit reporting agencies (Transunion, Equifax, and Experian) that lenders can use when making decisions about whether to extend credit or offer a loan. For most loan applications, lenders rely heavily on data from these agencies—delivered in a convenient credit score and credit report format.
Alternative credit includes information like rent payment history, gig economy income, utility bill payments, childcare payments, and more. Alternative credit scoring can increase loan approval rates, as credit reports fail to paint the full picture of a borrower’s creditworthiness.
For example, a lender might be unlikely to approve an applicant based on a credit score of 600 alone. However, proof of income sources and a long history of on-time rental payments—good indicators of repayment likelihood—could potentially change that decision in the borrower’s favor.
Alternative data also comes into play with credit invisibles, or people lacking a credit report or credit score. For these individuals, alternative data might be the only way to gain access to loans.
To use alternative data, lenders must first obtain it, and then add it to their loan-approval decision process. For the former, they can ask applicants to manually upload documents such as bank statements and pay stubs or use Plaid’s lending products to gain access to this information in seconds.
They can also choose how much weight they want to give alternative credit data vs. traditional credit report data—or even if they only want to rely on alternative data alone.
→ Want to verify assets and account ownership faster? Plaid’s asset verification APIs instantly provide an up-to-date view of a borrower’s bank accounts and assets.
What is alternative lending?
Alternative lending refers to the practice of providing loans and credit outside of the traditional banking system. It emerged in response to the often strict application process at traditional banks, which limited credit access to people and businesses that don't meet traditional credit requirements.
Alternative lending might refer to fintech companies like Money Lion, which offers consumers loans of up to $500 with no interest, fintech mortgage providers that consider alternative credit data, or peer-to-peer lending platforms. Fintech companies like Prosper connect borrowers and lenders, increasing consumer access to credit without interacting with traditional banks.
Alternative lending is becoming a crucial part of the overall financial ecosystem by allowing underserved consumers to access small lines of credit, reducing their reliance on high-interest loans, and building financial wealth for the long term.
What types of alternative credit data do lenders use?
There are many types of financial data lenders can use to evaluate borrowers outside of the traditional credit report. These include:
Spending patterns: Account information pulled from consumer bank and credit card accounts that shows money going in and out. Lenders can use this data to evaluate income and spending and determine if an applicant is eligible for a loan.
Bill payments: Regular bill payments for everyday life such as rent, utilities, phone, and insurance can be used to show that a loan applicant has a history of paying their bills on time—and can thus be considered creditworthy.
Rental payments: Rental history showing on-time payments over an extended period is a great way for borrowers to demonstrate their ability to pay off a loan. Rental payment data can be accessed either through property management companies or bank account transactions.
Alternative loan types: Some alternative loan types, such as buy now pay later (BNPL) loans and paycheck advances can count towards creditworthiness—though they’re not always accounted for in traditional credit scoring. Consistent repayment on these loans is another data point lenders can use to assess applicants.
Bank account assets: Historic, current, and pending bank account balances can help underwriters gain a more complete picture of a borrower’s finances. Lenders can ask borrowers to provide bank statements or link their bank accounts via an API-based data solutions provider. Plaid, for example, provides access to all the account information the lender needs in seconds.
Income data: Documents and bank inflows that show proof of income, such as pay stubs, 1099s, and W2s, are often used by lenders to determine a borrower’s creditworthiness. Just like bank statements, lenders can request loan applicants to manually upload these documents or use digital solutions like Plaid to directly connect with payroll providers and banks to retrieve this information in seconds.
→ Need a more holistic view of your loan applicants' finances? Plaid’s lending APIs connect directly with borrowers’ financial accounts to enable more informed decisions faster.
What are alternative credit scoring models?
Alternative credit scoring models include alternative credit data, such as rent payments or transactional activity, in addition to or as a replacement for traditional credit scores. This additional data creates a powerful borrower profile. A study by FICO found alternative credit scoring models are more powerful than traditional data alone.
Depending on the lender, alternative credit scoring models might include:
Transactional data, including credit and debit transactions
Rent and utility payments
Social network data
Website behavioral data, such as how they move through the lender's website.
Text or voice data during customer service calls
Survey or interview data
Lenders can analyze this combined data to create alternative credit scoring models and determine creditworthiness in a different way. However, there are privacy issues with some types of alternative credit data. For example, using social media data presents regulatory challenges and can be influenced by the borrower.
→ Watch the video below to see how the affordable housing company, PadSplit, uses Plaid to evaluate housing applicants with alternative data, rather than credit scores.
The challenges of alternative credit scoring models
Many fintech companies are relying on alternative credit scoring models to determine whether or not to extend credit to borrowers. However, there are challenges to the widespread adoption of alternative credit data. This includes:
Data quality and reliability: The accuracy of alternative credit data can vary. Some data sources may have errors or lead to misinterpretation.
Privacy and security concerns: Using data like website activity or social media history can present privacy concerns. Financial institutions must also make a plan to ensure privacy and security.
Lack of standardized process: Credit scores follow a standard reporting format, while alternative credit data does not. What is the value of 10 on-time rent payments or 2 years of on-time internet payments? Determining how this data predicts future payments can be challenging.
Ethical concerns: The use of some alternative credit data sources, like social media profiles or personal information, can raise ethical concerns related to data collection or introducing biases into the process.
Despite the challenges to leveraging alternative credit data, many organizations find that including alternative data sources in the credit scoring process has benefits for both lenders and borrowers, including the US Government Accountability Office and Consumer Financial Protection Bureau (CFPB).
→ Want to verify borrowers’ income and employment faster? Plaid’s Income APIs provide robust data pulls for employment and income verification in seconds.
Alternative data vs credit scores: What lenders use to make credit decisions
These alternative data types can help lenders build a more complete borrower profile to either replace or complement traditional credit scores. Even if lenders choose to continue using credit scores, adding alternative credit data to the mix offers useful benefits such as:
Up-to-date information: Credit scores are often a lagging indicator of creditworthiness, as they’re typically refreshed only once a month. Using alternative data such as recent cash flow and account balances provides a real-time view of a borrower’s financial state.
Added convenience: Integrating with an alternative financial data provider can make accessing alternative data more convenient. Borrowers simply log in to their online banking or payroll provider during the application process to unlock all the data lenders need in seconds. Moreover, doing so doesn’t negatively impact their credit score, unlike running a hard credit check.
Reduced costs: Running a credit check can cost lenders anywhere from $30 to $50 for each report. Pulling alternative data costs substantially less. In situations where lenders can rely on alternative data only, this can equate to significant savings at scale.
Greater insight: A credit report is a testament to having paid off previous debts, but it isn’t a complete picture of financial health. Alternative data provides greater insights into a borrower's current financial state and can even find new risk factors that credit scores neglect.
Ongoing access: A lender can easily refresh consumer cash flow information when shared digitally. This helps them monitor for changes in cash flow and gain access to more up-to-date information in the loan decision process.
Data such as missed rent payments or lack of income can actually inform lenders of risk factors for applicants with a good credit history based on traditional indicators (and, therefore, a high credit score). Alternative data provides due diligence that helps lenders avoid potentially risky lending and prevent borrowers from taking on too much debt.
In parallel, many people have steady incomes and asset profiles but have never taken out a conventional loan. In these cases, there’s either no or only a thin credit report to evaluate. Alternative data is crucial for helping these candidates access loans at favorable rates and build their credit history for the future. Of the estimated 49 million people in the US who don’t have a credit score, many would qualify for a loan based on alternative data.
Cash flow data is going mainstream
Hear what 400 lending professionals and 2,000 borrowers have to say about the next era of lending
Alternative credit scoring is a growing business opportunity
On top of expanding financial access to those without credit histories, alternative credit data enables lenders to approve more borrowers without assuming more risk. Experian estimates that an additional 19 million US adults could be properly evaluated for credit with alternative data—a sizable new market for lenders.
Moreover, the use of alternative credit data can help lenders offer matching or even lower rates than when using credit scores. One lender who integrated Plaid Assets and Income products to access alternative data during the application process has been able to offer 29% more loans at the same rate than when using traditional methods. Another has been able to use Plaid’s alternative data products alongside credit scores to offer 20% lower rates than when using credit scores alone.
It’s worth noting that consumers are largely in favor of alternative credit data: 70% of Americans say they’d be okay with providing more financial data to lenders if it were to lead to better-informed credit decisions. For lenders who want to expand their business to new customers, using alternative data expands their reach while helping them better evaluate potential borrowers.
19M additional US adults could be evaluated for credit by using alternative data instead of credit scores
The average credit limit for Flexport users who use Plaid is 32% higher than those who upload documents manually.
Current-to-late roll rates for Petal cardholders approved using cash flow underwriting (via Plaid) are 30% lower than those approved with traditional underwriting.
Alternative data expands financial access and equity
Being credit invisible or credit unscorable is directly correlated with age and income. Younger and lower-income individuals are much less likely to have a credit score or favorable credit report than their older or high-income counterparts. That does not make them less likely to have a steady income and pay their bills on time, however. The use of alternative credit files can help close these age and income-related gaps in financial access and equity, all while creating new business opportunities for lenders.
Additionally, alternative credit data can help those who recently arrived in the US gain a better financial standing or even start a new business. That’s because recent immigrants are less likely to have a credit score, as credit reports only take into account US-based loans.
The benefits of alternative data for lending are clear: Lenders get a wider pool and make better-informed decisions, applicants get more loan options at better rates, and individuals excluded from traditional credit scoring get their fair chance.
→ Learn how you can leverage Plaid's lending APIs to improve your loan application process with alternative credit data.