NEW YORK (MainStreet) — Credit bureaus are now using new methodology and additional data to assess the payment history of consumers. The changes boost consumers' credit scores and help lower the interest rate of their debt.
Credit bureaus look to see if consumers pay their bill on time each month for credit cards, auto loans and mortgages. A history of making late payments, or skipping payments entirely, can lower a consumer’s credit score; as a result, consumers often wind up receiving higher interest rates. A consumer who receives a high interest rate can wind up paying hundreds, even thousands, of dollars more than the initial loan.
But as the credit rating system evolves and teases out nuances in assessing borrowers, consumers will see an improvement in their ability to get loan requests approved -- and with more favorable conditions, to boot.
Rent and Utility Payments Are Now Included in Experian's Credit Score
Unlike credit cards and mortgages, on-time and regular utility and rental payments are not included in an individual’s credit report. Since 2011, Experian, the Costa Mesa, Calif.-based credit bureau, has started adding both payments as part of its credit score tabulations. It used to be you'd get dinged only if you were negligent in your payments; very few utility companies report timely payments to credit bureaus, instead advertising your negligence to them when you don't pay. But increasingly, customers who pay these bills on time will benefit, because it increases their credit history and potential lenders consider them as less risky. Not only will consumers have higher credit scores and fuller credit histories, but they will also receive lower interest rates for loans.
By including on-time utility payments in credit reports, Experian found there was nearly a 50% drop in subprime consumers with credit scores between 300 and 600, a 54% increase in consumers considered non-prime with credit scores between 601 and 660 and a 15% increase in those with credit scores over 661 (generally considered prime).
“Since gas and electric services are used by just about every household in the country, including these positive payments in their credit files provides millions of Americans with a way to build their credit history,” said Genevieve Juillard, president of Experian’s Consumer Information Services.
Experian was the first credit reporting agency to incorporate on-time rental payments in its database since “positive rental payments should be viewed as significant as timely mortgage payments,” she said.
“These individuals have a strong payment record, but it’s invisible to many companies looking at their credit profiles,” Juilliard said. “Without any record of on-time payments, these individuals often pay a premium for services such as utilities, cable and telecommunications and often higher interest rates for other types of credit.”
Subprime Consumers Receive Higher Interest Rates For Cards and Loans
Consumers with subprime scores between 300 and 600 often receive fewer credit offers, higher interest rates on loans and credit cards and have limited access to credit. By adding the rental data, the number of consumers designated as subprime dropped nearly 20% and those in the non-prime risk segment increased by 92%.
Adding rental and utilities data can help consumers like recent college graduates who have a limited credit history, to obtain a credit card or qualify for a loan, said Jeff Golding, CEO of WilliamPaid, a Chicago-based company which allows people to build credit through paying their rent online for free. In the past, many people could not qualify for a loan, because “they didn’t have enough credit since there wasn’t enough history to go on,” he said.
This new scoring method will allow lenders to see results over a period of time and will put consumers in a “better financing position, allowing them to borrow with better terms, lower payments and interest,” Golding said. “This helps them avoid the trap of being stuck in loans with high interest and high monthly payments loan that they can’t get out of.”
Paying More Than the Minimum Payment Can Increase Credit Score
A study conducted by TransUnion, the Chicago-based credit bureau, shows that a new way of classifying consumers called “CreditVision” includes additional data which can reveal trends and behaviors, such as when consumers make on-time payments, pay more than the minimum amount due, reduce total amounts borrowed or decrease utilization over time.
This new way of examining how debt is being paid means that 23 million consumers will be classified as super prime, which is the highest rating they can receive. People in this category receive better rates on credit cards and other loans, with 21% of consumers who are in this category compared to 12% before.
Consumers in the super prime category have a credit score in the range of 760 to 780, while prime consumers have a credit score of 660-680. This helps lenders identify “who will pay on time and who will be delinquent,” because they can examine the payment pattern and what is being paid, said Charlie Wise, vice president in TransUnion's Innovative Solutions Group.
The data can now allow banks, credit card companies and auto lenders to examine if consumers are paying more than the minimum balance and if the balance is being paid down steadily over time, which is more crucial than the traditional method of only looking at what a consumer’s balance was last month.
A consumer with a super prime credit score might pay 4% for a mortgage compared to someone who is deemed to be in the prime group and would pay the higher rate of 5%. A super prime homeowner with a 30-year fixed rate $200,000 mortgage would save $40,000, Wise said.
Millennials and People New To Credit Also Benefit
Transunion’s study also showed that 26.5 million consumers, who previously could not be scored, can now be scored using the new model. Nearly 3 million of those previously unscored consumers would be placed into the prime or super prime risk tiers.
This new scoring model benefits people who are new to credit, such as Millennials who are working at their first jobs and have no credit cards or people who just moved to the U.S. The model leverages an expanded view of credit data on each consumer that includes up to 30 months of historical information on each loan account.
“Now we can look at several months of data from one account and see their payment history, which is a huge benefit to consumers who are new to credit,” Wise said. “It means that millions more consumers may be offered lower interest rates resulting in reduced payments on credit cards, mortgages, insurance policies and auto loans.”
By expanding the window into a person’s credit history and looking for patterns, the credit bureaus are encouraging and rewarding consumers who adopt healthy credit habits such as paying their balances in full each month, said Bruce McClary, spokesman for the National Foundation for Credit Counseling, the Washington, D.C.-based non-profit group.
“This is another example of how credit scoring systems are evolving to represent more accurately the characteristics of modern borrowers,” he said.
--Written by Ellen Chang for MainStreet