What the FHFA Ruling Means for the Future of Alternative Data Use

Don’t be upset if your FICO score is missing the mark for mortgage eligibility, because we might have some good news for you!

This August, the Federal Housing Finance Agency (FHFA) passed a new rule, allowing Fannie Mae and Freddie Mac to consider alternative credit scores other than FICO. This comes as a major shift from their decision last year, disapproving the use of new credit scoring models like VantageScore. 

How will the FHFA ruling change the lending landscape?

Drive financial inclusion

The FHFA decision comes right after recent findings by the Consumer Financial Protection Bureau (CFPB), which showed that the usage of alternative credit models resulted in 27 percent more loan applicants and 16 percent lower average APR than traditional credit models. But there’s a catch: the online lending marketplace that conducted the research only deals in personal loans, so it is less applicable to mortgage financing. 

Alternative credit models resulted in 27% more loan applicants and 16% lower average APR than traditional credit models.

However, that does not take away from the fact that credit models that incorporate alternative data, promote financial inclusion, giving consumers with thin or no credit files a better chance of being approved for a loan. Hence, the FHFA ruling has immense potential to drive greater financial inclusion in the home sales market.

Advance risk models

As they say: your model is only as good as your data. Alternative data, including bank account history, rent payments, and utility data, has been of great interest to the fintech world, not only for extending credit but also to improve predictive modeling.

Adding more sources of payment history to risk modeling can increase predictive accuracy and overall visibility into applicants. This visibility pays off: research from McKinsey shows that lenders have cut credit losses by 20 to 50 percent, by incorporating alternative credit data into risk decisioning models.

Boost competition and innovation 

Fintechs and financial institutions have already been experimenting with new scoring models, but with this approval from the FHFA, firms will be more motivated to create innovative solutions based on multiple consumer data points. 

Increased competition in this space is expected to break the monopoly of traditional risk models and promote fairness. Companies that have already taken the lead in alternative credit scoring will have an edge on those just starting to venture into the space. 

Rebuild consumer trust

In the new age of data privacy, consumers are wary of giving out personal information. However, the FHFA ruling lends credence to alternative credit scoring, giving consumers more of an incentive to make data sharing worthwhile.

Plus, given that alternative credit scoring is still an emerging practice, there’s room for innovation. Lenders and credit reporting agencies can take a proactive stance and prioritize consumer-permissioned methods of accessing alternative data. Equifax has already taken steps to drive consumer empowerment with its new partnership to acquire permissioned utility payment data.

How will the FHFA ruling impact compliance?

Spur innovative verification

In February, Moody’s predicted that mortgage delinquencies will continue to be on the rise due to lenient underwriting standards. As more and more thin-file customers are targeted by credit agencies, financial services providers will face greater challenges to verify them. They may need to rely on new tools or new identity verification services to maintain KYC and AML compliance. 

As more thin-file customers are reached, financial services providers will face greater challenges to verify them.

Thankfully, alternative data can be a useful tool for identity verification as well. New technology can automate traditionally manual, fraud-prone processes like utility bill verification with automated data collection. Regardless of the method, financial services providers will need to prepare for this new wave of customers with innovative verification procedures in place.

 

Although the future looks bright for borrowers and lenders, the industry should remain aware of the risk of fraud, not just the reward of extending credit to a larger population. That said, the FHFA ruling is a good sign that the use of alternative data will be on the rise for years to come.  

Interested in learning more about the impact of alternative data on credit risk modeling? Check out the results of our recent study. 

RELATED RESOURCES:

• eBook: Who’s Who? Identity Verification in a Digital World
• Majority of U.S. Adults Are Willing to Share Utility and Telecom Data with Lenders
• KYC Compliance: The Building Block to Verifying Customer Identity

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