A bad credit score is like a bad hangover. It’s hard to shake. Worse, having one can make it hard to get a loan or mean higher—sometimes predatory—interest rates.
If a growing number of startups led by data geeks get their way, what’s known as a FICO score—the standard for evaluating credit since the 1980s—could one day go the way of shoulder pads and stirrup pants.
"It’s an extremely generic measure that serves lenders well" says John Sun, co-founder of the Chicago-based company AvantCredit. "Traditionally, a person sitting there looking at your file needed to remember a few simple rules about what to do."
AvantCredit’s model considers more data about a person than traditional lenders, looking at factors like an applicant’s use of social media or a prepaid cellphone. The idea is that AvantCredit may offer more carefully calibrated rates to people who are normally considered higher risks. Or it might award a loan when a traditional bank would not.
In the last year since it was founded, AvantCredit has made more than 5,500 loans totaling $15 million, says Sun. It recently raised $20 million to expand to more states. The company targets middle-income families who have credit scores in the 580 to 700 range—a level just below what is usually considered a "good" credit score. Because these applicants are often turned down by banks, some may be forced to pay higher rates than they deserve with payday lenders, says Sun. On AvantCredit, the application is done fully online and an automated decision—and the rate they’ll pay—is made within minutes. Transparency is the goal, he says, and the company has skin in the game because it backs its own loans.
While AvantCredit focuses on the middle class, other tech startups, such as ZestFinance and LendUp, are looking to change the "subprime" lending category by offering more transparent terms and sussing out good credit risks, even among those who may not seem so by surface measures. ZestFinance, a startup founded by Google’s former Chief Information Officer and CapitalOne’s former head of subprime credit cards that licenses software to underwrite loans, says that "all data is credit data." It tabulates thousands of variables that it has found to correlate with the likelihood of repayment—even down to whether a person uses proper capitalization on the web form.
Banks can be slow to change, but if done well, better credit models might extend loans on fairer terms to a large swath of society. Payday lenders, which can trap people in cycles of debt, cost the economy nearly $1 billion in 2011 alone, according a recent report by the Insight Center for Community Economic Development.