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For those whose mailboxes bulge with credit card offers for everyone in the family, including the dog, this may be hard to believe. But an estimated 50 million American adults have no real credit history.
So says Fair Isaac, the company that developed the classic FICO score used by most lenders, and they've launched a new scoring system that may soon allow lenders to make loans to more recent immigrants, young people and others who currently have a tough time getting credit.
But with this development, called the FICO Expansion score, also comes new ways for people to mess up their financial lives.
The new system helps lenders gauge applicants who don't have much, if any, traditional credit history. Instead of using credit bureau files to calculate the three-digit number, however, the FICO Expansion formula draws on databases compiled by "nontraditional" sources, such as:
- Payday lenders.
- Rent-to-own stores.
- Companies that monitor (and blacklist) people who bounce checks.
Fair Isaac believes that these databases will allow it to generate scores for half of the estimated 50 million people in the United States who either have no credit bureau history at all or whose history is too thin to generate a regular FICO score.
That could help lenders reach more young people and minorities who have been poorly served by mainstream financial institutions. But the big market is immigrants: both those who have never used traditional credit and those whose credit histories didn't translate to these shores. (Even people with stellar credit in their home countries typically find they must start over in the United States because their credit histories don't show up in the bureaus here.)
Mining good risk
The score was just introduced to lenders this summer, so it's too early to tell how widely adopted it will be. But lenders know there are a lot of good risks in these so-called "underserved" populations -- people that would pay back any money they were loaned, plus a healthy dollop of interest.The trick, as always, is culling those good risks from the bad, and Fair Isaac promises its new score will be just as good at predicting potential defaulters as its traditional scores.
An interesting sidelight: Unlike some other companies trying to serve this market, Fair Isaac so far is steering clear of using rental payments as a guiding factor.
A few mortgage lenders, including Countrywide Home Loans, have loan programs that allow borrowers to use rent, utility and telephone payments to help establish a credit history. Another company called Pay Rent, Build Credit, or PRBC Inc., allows consumers to register such payments to demonstrate their creditworthiness (although as yet no loans have been based on this registry).
Will the new score help or hurt you?
But Fair Isaac said it couldn't find a reliable enough database of rental payments and, more importantly, there are questions about how "predictive" rent payments are. In other words, your ability to handle a checking account and pay off a TV at a rent-to-own outfit might say more about your creditworthiness than whether you've managed to get the landlord a check each month.Now, it's easy to see why credit card companies, mortgage lenders, wireless carriers and others might be interested in the new score. The question is whether it will be a bonus or a burden to those it's designed to measure.
Here are some ways you could be worse off:
If you've mishandled a checking account. Typically, people who repeatedly bounce checks (and who don't have overdraft protection) can wind up on blacklists created by companies like ChexSystems. These blacklists can prevent you from getting another bank account for five years. But this information usually isn't reported to credit bureaus, so lenders who use traditional credit scores might not know about your troubles. Those who use Expansion scores probably will. (Some lenders might use both.)
If the new score becomes just another "sucker list" for lenders. What if some lenders use the score to identify people who are already overpaying for credit, just so that they can be pitched more high-rate loans? If you're someone who uses a payday lender, you might not realize that a 29.9% credit card is a lousy idea, and you could find yourself falling further into a hole.
If the existence of this score tempts you to use a payday lender or rent-to-own company. Payday lenders charge interest rates of 300% and more, and you can pay for an item purchased through a rent-to-own outfit 10 times over. These lenders feed off folks who either don't know how to manage their money or are so strapped they feel they have no other choice.
Try for a real credit score
While the Expansion score may give some borrowers a faster route to credit, the traditional ways of establishing credit history are still the best. They'll cost you less and ensure you access to a broader array of potential creditors. These steps include:- Establishing (and responsibly using) a checking and savings account. These aren't reported to credit bureaus, but lenders see them as a sign of financial stability.
- Applying for department store and gas cards. These are typically easier to get than major credit cards like Visa or MasterCard.
- Applying for a secured card. These give you a credit line that's equal to an amount you deposit with a bank, usually $200 to $1,000. Look for a card with reasonable fees that reports to all three major credit bureaus and that converts to an unsecured card with 12 to 18 months of on-time payments.
- Getting an installment loan. A personal or car loan can really help jump-start your credit history.
- Practicing good credit habits. These include paying your bills on time, all the time; never using more than about 30% of your available credit; and not applying for a bunch of credit at once.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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