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Beware of the rush of alternative credit solutions

Nov 11, 2016 Walt Wojciechowski

Beware of the rush of alternative credit solutions

Between millennials shunning traditional financing models and the number of underbanked individuals in the United States, it's clear to see why lenders are turning toward alternative credit data.

"Collecting data from third-party providers introduces data quality risks."

In response to the shift away from traditional credit, financial technology startups and credit bureaus are rolling out alternative data products left and right. Companies which have no previous experience collecting, validating and processing alternative credit information are now touting themselves as authorities.

While there's nothing wrong with having plenty of choices, lenders need to be aware of the fact that alternative data providers are jumping on the bandwagon. The rush to provide alternative credit data increases the risk to lenders who need dependable information to assess borrowers' creditworthiness. How can they identify alternative credit solutions that provide reliable, accurate data?

Classifying poor alternative credit products
Many of the problems with new-to-market alternative credit solutions lie in how their developers collected information, putting you at risk of referencing inaccurate data to make important lending decisions. Listed below are two signs that an alternative credit data provider did not gather information appropriately:

  • The provider gathered data from a third party: There are a few risks associated with third-party data, according to Gigya. One of those risks is that third-party data providers may not update consumer information consistently. Information that's six months old wouldn't tell lenders if a consumer moved, purchased a car, switched bank accounts or made some other financial decision.
  • The provider combined alternative and traditional data: Depending on the algorithms used to develop scores, calculating alternative and traditional information together isn't inherently bad. However, it opens up the risk of misrepresenting transactions and their connection with credit behavior. For example, if a consumer misses a credit card payment around the same time an unforeseen medical expense arises, that doesn't necessarily mean the latter event caused the former to occur.

Experience is also an issue of which lenders should take note. Companies that specialize in traditional credit scoring may offer alternative data products, but they've only started analyzing such data in recent years.

Quite a few startups are trying to figure out how to sort through alternative data.

Identifying quality alternative credit solutions
Businesses should seek companies that specialize in collecting and analyzing alternative data when seeking such products. If a prospective provider has built its operations around processing alternative credit data, it's likely a more secure choice than competing solutions.

In addition, the provider in question should have at least 10 years of experience under its belt. A startup may place alternative credit data at the center of its operations, but that doesn't mean it's refined its practices yet. Almost one fifth of startups fail due to poor products, according to CB Insights. Lenders must keep this in mind before establishing working relationships with businesses new to alternative credit data.

At minimum, an alternative credit product should provide the following information in a logical format:

  • Trade lines (rent, utilities, short term loans).
  • Banking inquiries.
  • Positive and negative retail bank transaction items.
  • Any liens, judgments or eviction records.
  • Current and previous address history.

Some of these attributes may not seem relevant, yet they not only provide context but also confirm the identities of borrowers applying for loans or lines of credit.

There are many options out there, but be wary of newcomers. Many of them are still getting the feel for how to collect alternative credit data, let alone how to formulate accurate reports.