Do we need a vaccine for credit scores?

Time to find a new prescription that works for everyone.

A week after Seth* celebrated his 22nd birthday, he landed his first full-time job in San Francisco. One of Seth's co-workers asked him if he would be interested in going on a trip with the team later in the summer. Seth said, "of course, I would be thrilled to."

Who wouldn't be? Seth doesn't have any savings yet, so applied for a travel credit card. Tada! To his surprise: he was declined! He had a handsome salary, so he didn't understand why he wasn't approved. Seth, like thousands of others, did not have enough credit history to get a card.

Seth started building his credit, but had to go into debt to do that. Fourteen months later, he finally got to go on a trip with his team. Yay!

Building credit takes time, and one has to go into debt to do it. Isn't that counterintuitive?

Across the country in Atlanta is Kathlyn*, who is buying her first home. The process began with a credit check for pre-qualification, and she was thrilled to be pre-qualified on the first try. Kathlyn then picked out a property. The seller accepted her offer. Everything looked good, and there was another credit pull done before closing. But, just when Kathlyn thought the deal was done, a last-minute issue brought the deal down. Kathlyn was okay with this and found another dream property and was excited again!

But this time, her prequalification was declined. Kathlyn really couldn't understand why! The two back-to-back inquiries on her profile lowered her credit score and cost her her dream.

Kathlyn says during the mortgage process, "They tell you to stop spending on your credit card, stop doing all these things, so you don't blow up the mortgage. Then you're living in this fear of 'can I do anything?' and you're paralyzed for 30 to 45 days while waiting to close. It's a paralyzation of being able to live your life."

From credit-card bills to a Netflix subscription, Kathlyn never missed a payment in her life, yet this happens. This process is especially concerning when a home buyer might be shopping for extended periods to find available homes, like what is happening now.

We already have these issues with credit scores, and then there is bias!

It's no secret that biased data and algorithms skew automated decision-making that disadvantages low-income families and minorities. According to a recent survey, about 54 percent of Black Americans say they don't have any credit or have a poor or fair credit score below 640. Forty-one percent of Hispanic Americans fell into the same category compared to 37 percent of White Americans and 18 percent of Asian Americans.

Since the credit bureaus look at transactions like mortgage payments to calculate their scores, building good credit can be nearly impossible for consumers living paycheck to paycheck and who can't access credit products to build their history. As you take credit history into account, you are putting people at significant risk and greater bias. So, it is not just about the algorithms automating credit scores, but, more importantly, the conscious effort on what data one has to consider for modeling scores.

About 50 percent of the population is missing out on access to credit due to noisy data and algorithms! It is unacceptable!

Laura Blattner and Scott Nelson recently published a report on how reducing noise and equalizing the precision of credit scores can reduce disparities in approval rates. They found it can reduce credit misallocation for disadvantaged groups by approximately half. This was probably the first large-scale experiment done. The results are a startling reminder of how serious the problem is. This is huge for consumers but also imagine the vast missed opportunities for lenders and financial institutions!

How to create a credit score breakthrough?

When the concept of the credit score was created, it was supposed to be a fair, unbiased method to rank the creditworthiness of Americans. Still, there are growing concerns that that isn't the case, and there are bugs in the system. With so many technical and societal inequalities embedded, it affects many like Seth, restricting thousands like Kathlyn from realizing their dreams and not giving equal access to wealth to millions of minorities and low-income consumers. How do we create a breakthrough?

1. Trace the credit bug’s DNA.

To trace the DNA of the source and its mutations, we need more data. Banks have to lend to more people who are disadvantaged by the current scoring system to get more data on the affected population. This concept may sound ridiculous to compliance teams, but we won’t eliminate the historic bias and discrimination unless we get new data. One way to make this happen is to use the CRA loans genuinely and not just for marketing or predatory lending. By doing so, financial institutions will learn more about the left-out population and benefit consumers, financial institutions, and our society to eradicate the bug in the long term.

2. Use over-the-counter data.

Until we find enough data and create equitable models, financial institutions should use readily available data like transactions, income, expenses, and utility payments to supplement existing credit scores. And more importantly, also consider behavioral patterns and factors that influence the financial health of consumers. Recently a few financial institutions announced that they would consider certain transactions as an additional source of risk assessment for consumers with no or poor credit. This method came as a wake-up call only because big lenders saw declines in credit card issuances and balances this year. Let's not wait for the next financial health pandemic to happen.

3. Don’t force consumers into a debt prescription.

Going into debt to build credit is like getting sick to use your medical insurance. The system shouldn't punish consumers who use debit cards. After all, using a debit card is the best medicine for excellent financial health. Many modern-day innovations like round-ups, crypto rewards, buy now pay later(BNPL), and more are already making savings effortless and credit products obsolete. Our credit system should evolve, and the prescription for good credit should be more than just debt.

There are bugs or viruses in the whole system, which affects 20-year olds to 60-year olds and even financial institutions. So, can we develop a vaccine to get rid of it? If yes, how can we do it?

*Names have been changed to protect identity.

BOND.AI provides artificial intelligence for finance, powered by the world's first Empathy Engine. Embed its SDK to help your consumers and small businesses remove financial uncertainty. The Empathy Engine acts as a genuine superpower for consumer financial health. When data is run through this engine, it creates unique personas for every consumer or a small business of your bank or fintech app. A persona that connects their behaviors, strengths, potential needs to understand them holistically and creates multiple paths to boost their financial lives. Learn more about how BOND.AI combines its onboarding experience, text and voice bot, and persona clusters to drive customer engagement and improve financial wellness by visiting BOND.AI.