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Credit scores are evolving. For some consumers, that could be a blessing.
First, the basics: Your credit score is used by institutions including banks, credit card issuers, auto dealers and others to determine whether to lend you money or not, and if so, at what interest rate. The higher your score, the better the deals you are likely to get.
There are two main providers of credit scores in the U.S. A company called FICO produces the dominant metric used by most lenders, which is a value between 300 and 850. It's probably what comes to mind when you think of a credit score. Its biggest competitor is VantageScore, created by the big three U.S. credit bureaus, Experian, Equifax and TransUnion.
Both scores have different models, and lenders use different versions. But they primarily take a person's payment history, credit utilization rate, length of credit history, types of credit accounts and recent credit account openings into consideration. Payments and balances for credit cards, mortgages, student loans, auto loans, etc., are all reported to the credit bureaus.
The factors that influence scores are evolving for many reasons, one being that consumer advocates have numerous complaints against FICO and VantageScore. Some say it is unfair that there are basically only two private scoring models that have so much sway over Americans' finances; others say that the system is inherently biased against low-income people and those without generational wealth. So in recent years, there's been a move to incorporate alternative data into credit score calculations.
Alternative data is anything outside of the traditional credit reporting system, such as rent, cellphone and utility payments or bank account cash flow. Many banks already base their lending decisions off of a combination of someone's FICO score and some of the other factors listed above, and The Wall Street Journal reports more are starting to create their own scores.
For its part, FICO introduced the UltraFICO score a few years ago, which takes a person's banking activity into account when determining their creditworthiness. There is also Experian Boost, which takes cellphone and utility payments into consideration.
Including alternative data in lending decisions could potentially open up credit opportunities to the tens of millions of Americans with thin to nonexistent credit histories, says Chi Chi Wu, an attorney at the National Consumer Law Center. FICO takes mortgage payments into account, which benefits homeowners. Why not rental payments, too?
"The consumer should be the one deciding whether to allow a lender to access bank account information, or if rent data is reported," Wu says.
At the same time, problems could arise. Wu points to the Covid pandemic, in which millions of Americans fell months behind on housing payments, as evidence of how including on-time rent payments in credit reporting could go awry for consumers. Reporting utility payments, too, could potentially hurt low-income people's credit histories.
"A lot of low-income households might get behind by 30 or 60 days on their heating bill in the winter, but they know they can catch up come April," she says. Having two or three months' worth of late payments would hurt their scores when the addition of utility payments was meant to help.
But for now, FICO is too ingrained in the financial system to be replaced completely, Wu says. Some banks and lenders may have their own custom credit models, but most are still based around FICO, so it's worth keeping an eye on.
Below are some articles filled with tips from CNBC Make It on how to boost your FICO credit score:
- Aiming for an excellent credit score? These 2 factors are the most important things to focus on
- This mistake could drop your credit score by as much as 50 points—here's how to avoid it
- Follow these 3 steps to improve your credit score
- How to calculate your credit utilization rate
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