Credit scores are the linchpin of the consumer lending system — and they’re mostly focused on debt.
Banks need to have a way to measure the risk that customers will default on their loans so they can decide whether to lend, how much and at what interest rate. But the main financial behaviour credit scores pick up on is the ability to pay back debt. Usually, it doesn’t matter much whether you’ve never missed rent or have been dutifully squirrelling away money into your savings account.
That may be about to change. In the U.S., Fair Isaac Corp. (FICO), creator of North America’s widely used FICO score, is rolling out a so-called UltraFico score based on how cash flows in and out of customers’ chequing, savings and money market accounts. The company is planning to roll out the new score early next year.
By signing up through an app, Americans who agree to data collection from their bank accounts will get an UltraFICO score that could boost their FICO score. That could improve their chances to be approved for a loan or allow them to borrow at cheaper rates.
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The company says seven out of 10 consumers who show average savings of $400 without going into overdraft for three months will see a credit score boost. It also estimates that 15 million consumers who currently don’t have a regular FICO score could get an UltraFICO score. The idea is that this could be a toehold on the credit score ladder for many people.
It isn’t clear how soon the UltraFico score will make it to Canada. Credit bureau Equifax Canada, which uses a number of FICO scores, told Global News it’s “too early to share specific details on new scores.” TransUnion did not return a request for comment.
But others are working on coming up with new ways to calculate customers’ credit default risk.
In Ontario, DUCA Credit Union is also trying to develop metrics for lending without using borrowing history.
One of its pilot programs targets Canadians with low credit scores. Through a partnership with fintech startup CacheFlow, the credit union is hoping to be able to lend to those with low credit using their cashflow data.
CacheFlow’s software for financial advisers creates a cashflow plan that, among other things, tells clients how much they can spend every month in order to achieve their savings or debt-repayment goals.
Working with Prosper Canada, a financial literacy charity, DUCA plans to offer cheaper loans to CacheFlow users with low credit scores who would normally turn to expensive debt options like payday lenders. The credit union will structure loan repayments according to each individual’s cashflow.
The goal is to lower the share of income that goes to loan repayment and, in the long run, help clients be debt-free or graduate to mainstream lending.
“What you don’t want to do is find a new way to assess credit, only to fill a gap with another loan that’s reused all the time because all you’ve done is put a Band-Aid on a symptom,” DUCA president and CEO Doug Conick told Global News.
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In a similar vein, the credit union is also focusing on professionals who are newcomers to Canada, where they have no credit history.
It can take some time for, say, a doctor from Southeast Asia to be able to practice in this country. Accreditation is often a complicated and expensive process, said Keith Taylor, executive director of the DUCA Impact Lab, which is spearheading these new lending initiatives.
With no access to credit, foreign-trained professionals often end up getting a low-paying job so they can support their families, Taylor said. And that can significantly delay and sometimes compromise their ability to get Canadian licencing.
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But is it all good?
Licensed insolvency trustee Doug Hoyes is no fan of the old way of calculating credit scores.
There are some obvious problems with the current system, which “rewards borrowing,” Hoyes said.
For example, current credit rating models recommend borrowers who use a low percentage of what they can take out on revolving credit accounts such as credit cards and lines of credit. This means that someone with three credit cards, each with a $10,000 limit and a $3,000 outstanding balance, may have a better credit score than someone earning the same income who has a $600 balance on one $1,000 card, Hoyes wrote in a blog post.
“That is ridiculous,” he said.
Relying on a record of cash transactions could be a good thing, he added, but the devil is in the details.
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For one, Hoyes is concerned about privacy.
“This creates a pipeline to your bank account. Is it worth it?”
After all, he noted, credit bureaus have not been immune from data hacks. In 2017, Equifax revealed it had suffered a breach that affected nearly 150 million Americans and over 19,000 Canadians.
The other question is whether a cashflow-based risk rating could also end up encouraging consumers to take out loans they can’t comfortably afford or aren’t able to manage.
Relying on banking information would eliminate the need for people to take out loans they don’t need just so they can build a credit history and work their way up to, say, being able to get a mortgage.
It could also benefit individuals with low credit scores who display financially responsible behaviour.
But Hoyes worries they could also encourage some to borrow too much too soon.
For young people and those new to Canada and its financial system, it might not be a bad idea to be able to borrow only small amounts at first.
“If you don’t pay off your $500 credit card, that will rarely be financially fatal,” he said. Missing payments on a mortgage would be a much more serious mistake.
“I can see how (the new system) could help some people but also hurt others,” Hoyes said.
For his part, DUCA’s Conick says he’s determined to stay on the right side of that fork in the road.
“What I don’t want to get us involved in is finding a much better mouse trap to assess risk and provide credit that can be abused,” he said.