How Lenders Use Your Hidden Credit Score

Before you go, we thought you'd like these...
FICO credit score
Alamy
By Hal Bundrick

Is the National Security Agency really tapping your phone calls and reading your email? If they are -- in spite of the invasion of privacy concerns -- the truth is, it's probably some pretty boring stuff they're snooping in on: "Want to meet for lunch?" "Justin Bieber got arrested?" "Who's the new guy in accounting?" That sort of stuff.

The real data that matters is much more personal. Lenders use it, and you should know about it. It's your hidden credit score.

Lenders Easing Credit Standards

After years of suffering, consumer credit is gaining giant momentum. Crawling out from the rubble of recession, lenders are looking to make deals.

The "too big to fail" banks have been mopping up lingering legal messes, and the mortgage industry is still in recovery. But consumer-focused lenders have been easing credit standards and swimming downstream to gain retail customers and pump up profit margins.

These mostly smaller lenders are finding a good deal of opportunity with consumers who have less-than-perfect credit. But they don't depend solely on your traditional credit score. They need more than that.

Subprime Time

The term "subprime" has become synonymous with the U.S. financial crisis of 2008. Tied to the manic mortgage industry that fueled the economy in the early 2000s, subprime loans were packaged as derivative investments and ultimately caused the collapse of the house of cards that was the American economy.

But subprime lending -- issuing loans to consumers with FICO credit scores of 660 or below -- is making a comeback. And rather than causing concern for another crisis, it's helping credit-critical consumers rebound from the recession.

It's also feeding the heat of a resurgent automobile industry. The credit bureau Equifax (EFX) reports that auto loan volume was at an eight-year high last year, and nearly a third of those loans were issued to subprime borrowers.

For Americans with complicated credit histories, the opportunity for a financial reboot should continue for awhile longer. Moody's Investors Service (MCO) says subprime borrowers can expect the favorable lending environment to continue through at least the end of 2014.

Alternative Credit Data

How are lenders managing credit risk when dealing with consumers with low credit scores? It's all a function of big data -- the term given to the collection and interpretation of a multitude of data gathered from a variety of sources.

In effect, %VIRTUAL-article-sponsoredlinks%it's a hidden credit score, built upon a "predictive risk" rating generated from non-traditional payment histories. That means rather than simply examining typical revolving credit accounts and personal loan histories, lenders are looking at payment behavior tied to cellphone, landline, utility and cable and satellite TV payments.

This data provides insight into millions of consumers with "thin files" -- meaning potential borrowers with little, no or recovering credit histories. In fact, a reported 25 million consumers are nowhere to be found in traditional credit files, according to Equifax. Alternative credit information allows lenders to serve this previously untapped market.

Credit reporting agencies know more about us than most consumers would believe -- from income information and your home address, to public records and wealth profiles. All this information serves to develop our credit risk rating that is provided to subprime lenders, and it is driving the credit-bruised consumer lending boom. As privacy intrusive as the practice may seem, it can work to your advantage.

An Excellent Time to Repair Your Credit

With relaxed credit standards and motivated lenders using alternative data to close a deal, Americans who have seen their credit ratings sag can use this rare opportunity to restore their credit score.

Making a sensible purchase in this easy-credit environment will allow you to begin rebuilding a positive credit history. Timely payments, combined with careful management of your debt load, will help your credit score rebound. It takes time, but most of us don't need to overload our credit capacity anyway.

Knowing the information is out there can give your credit file a counter-intelligence edge.

Hal Bundrick is a certified financial planner and former financial adviser and senior investment specialist for Wall Street firms. He writes about retirement accounts and personal finance for NerdWallet.


More from U.S. News

12 PHOTOS
11 Money Excuses to Stop Making in 2014
See Gallery
How Lenders Use Your Hidden Credit Score

Nearly one in four people say they don't have money to contribute to retirement after all the bills are paid. It might feel that way sometimes, but if we can find the $50 to go out to dinner every Tuesday night, we can find $200 a month to put in a retirement account. Make this happen, even if you have to do it one dollar at a time over the course of the month.

And if you think putting away $50 a week won't make a difference, consider this: Contribute just $200 a month for thirty years, and if your money grows on average 8% a year, your total contributions of $72,000 will grow to almost $300,000 if put away for 30 years. When you think about it that way, skipping that regular Tuesday dinner doesn't seem so bad, does it?

This is one of the most seductive retirement lies. For a good long while, it is true that retirement is a ways off. (Even if you're 55, it's still at least ten years away.) But the longer you put off saving for retirement, the less interest you'll earn and the more difficult it will be for you to save.

An example: Alex and Jordan both put just over $90,000 in their retirement accounts over the years, but Alex began saving ($2,000 per year) at age 22, while Jordan began saving (about $3,500 per year) 20 years later at age 42. Even though they both put in the same total amount, Alex will have over twice as much money at retirement as Jordan will when they reach age sixty-seven (assumes a 6% annual rate of return). That's because her money had more time to grow, so it was able to make more off of itself than Jordan's.*

Seriously, you have two people who put the same dollar amount into their retirement funds. The one who started twenty years later contributed the same amount, but ended up with less than half as much.

As someone who cares about making my money work for me, this speaks volumes. It turns out that one of the smartest things you can do is simply to get time on your side. This is how you shortcut the hard work-by taking advantage of the power of compounding interest and the fact that you will only have an increasing number of financial obligations pulling at your purse strings as the years go by. So, this is not something you can keep putting off. This is something to tackle today. The time is now.

* Note: This is illustrative and is not reflective of guaranteed profits over time. Actual results may fluctuate based on market conditions.

I bet all the married people reading this are having a good laugh right now. Marriage does not automatically make your financial life easier. The effect of marriage on your finances depends on a host of factors: Do you both work? Do you both make enough to support yourselves? If one or both of you got laid off, could you still afford your rent or mortgage? Are you honest with each other about your spending? Do you agree on your financial goals? Will you have children? If so, do you make enough that one of you can stay home with them? Bottom line: This is an outrageous excuse, and now I am drinking wine.
Maybe today's retirees can say this. But the future of Social Security is uncertain. Anyone retiring in the coming years should not rely on this as a be-all and end-all. If the system doesn't go bankrupt and you get to plan B? I don't know about you, but that's a risk I won't take.
I hear you. But saving for retirement versus enjoying life now is not an either/or proposition. You can do both. Also, let me put it this way: Yes, you deserve to enjoy

your money now, but you also deserve not to count pennies when you're old.

This is a case of counting chickens before they hatch. You never know what could happen to the inheritance (it could be devoured by medical bills, it could dwindle away in a financial crisis, or you may need it to pay off debts or taxes of the estate). Sure, it would be nice to inherit a windfall and be able to put it toward your retirement, but counting on doing so is not a plan-it's a gamble at best. It's far safer to plan to fund your own retirement and then enjoy your inheritance as a bonus if you do indeed receive one.
Yes, the market is unreliable from year to year, and yes, the value of your investments will dip in a down market. But downswings don't last forever, and historically, over long periods of time, the market has shown solid returns. While past performance doesn't reveal future returns, the S&P 500, for example, has averaged 9.28% annual returns over the last 25 years.

Alternatively, let's say you leave your money under your mattress or even in a savings account bearing 1% interest: You're going to lose the purchasing power of those dollars due to inflation (which is estimated at 3%). Yes, with the market, you're opening yourself up to some risk -- but with risk comes reward.

No one can predict the market. No one. So while it's true that you cannot time your investments perfectly so that they only ever go up, history has shown that if you invest regularly over decades, your investments should experience more ups than downs. So invest for the long haul, and don't fret over minor dips now. If you do, you'll be missing out on an opportunity to amass money later.
Sure, selling your home will free up lots of cash ... but then where will you live? And what if the market is down when you want to sell that home? Remember the housing crisis a few years ago? The one where tens of thousands of near retirees were left without nest eggs after the values of their homes plummeted? This is not your smartest game plan.
Yes, college is a big expense, and you should definitely save for it-that is, once your own retirement needs are taken care of. If you're a parent, it's a natural instinct to put your children's futures before your own. But think about it this way: If you don't save the full amount for your children's college education, you can always fall back on financial aid, grants, scholarships and student loans to help pay your children's way. When it comes to your retirement, however, there are no loans. Let me repeat: There are no loans. All you'll have to live on is what you've saved. For that reason, saving for retirement should be your top financial priority-always. I get that you don't want to saddle your kids or future kids with loans- what parent would?

But remember that if you pay for your children's college and then cannot afford your retirement, you will end up burdening your children all the same. They will feel obligated to help you out-at a time when their own families need them financially.

You may love your work, and it may be the kind of work you can even imagine yourself doing well into your seventies or eighties. But while that's easy to say now, what if you can't find work at that point in your life, or what if you have health problems or family obligations that prevent you from working? While there is nothing wrong with hoping for a best-case scenario, it isn't wise to plan around one. Sock away some money now so you're ready for whatever may come your way. The last thing I ever want you to deal with is a health issue and money concerns at the same time.


Reprinted from the book "Financially Fearless: The LearnVest Program for Taking Control of Your Money" by Alexa von Tobel, CFP®. Copyright 2013 by Alexa von Tobel. Published by Crown Business, an imprint of the Crown Publishing Group, a division of Random House LLC, a Penguin Random House Company.

of
SEE ALL
BACK TO SLIDE
SHOW CAPTION +
HIDE CAPTION
Read Full Story

People are Reading