A Different Way to Size Up Credit

About 50 million Americans don’t have enough credit to get credit, but that may change as a result of a scoring system recently launched by Fair Isaac Corp., the Minneapolis-based developer of consumer credit scores.

Fair Isaac has developed an “extended” score that will pull information about people from nontraditional sources, such as payday lenders, rent-to-own furniture retailers and deposit accounts.

The idea is to flesh out credit files on recent immigrants, divorcees, students, widows and other people who may lack enough of a traditional credit history to support a standard credit score -- the basis on which most lending decisions are made.

“Between 5% and 15% of all loan applications are just dropped on the floor because there is no score available for that person,” said Craig Dillon, vice president of global scoring solutions at Fair Isaac. “We believe we will be able to provide scores for about half of that population.”

Consumer advocates and credit experts had mixed reactions to the news, saying that it was too soon to know whether the expanded scoring model, announced last month, would be a boon or a bust to the credit-deprived.

“The question is whether this new score will give you access to fair loans that have reasonable terms, or is it going to put a bulls-eye on your back that tells every sleazy company out there that these are people you can target for high-cost, abusive loans,” said Travis Plunkett, legislative director for the Consumer Federation of America in Washington.

Joel Greenberg, president of credit counseling service Novadebt in New Jersey, also called the new scoring model a mixed bag. “It is possible that this will provide lower interest rates to a segment of the population whose only option now is maybe to get a payday loan, which is as predatory a loan as you can get,” he said. “But there are enormous pitfalls.”

Credit scores have become pivotal in recent years because the lending process has become increasingly automated. Where bankers of yesteryear would sit down with a borrower and try to assess their ability to repay a loan based on their assets, then manually check their payment record on other obligations, today’s borrowers rarely meet a banker. They frequently apply for loans over the phone or via the Internet.

The determination of a borrower’s propensity to repay a loan is left to computerized models that spit out a so-called FICO score ranging from 300 to 900. The higher the score, the lower the default risk, according to Fair Isaac. From the consumer’s standpoint, the higher the score, the easier it is to get credit and the better the loan terms.

However, to get a score at all, people need to have some recent payment history, usually with traditional lenders such as banks or credit card companies. About 20 million people have no credit information on file, Dillon said. Another 32 million have some information on file, but the data are too sketchy to create a traditional credit score, he said.

Having a thin or nonexistent file doesn’t mean that a person has no bills or payment history. It simply means that they have little history with the types of companies that report to credit bureaus. A vast array of payments -- including rent, utility bills, medical bills and payments for goods bought on layaway plans -- aren’t recorded in a traditional credit file, Dillon said.

“In credit, past performance is the best indication of future behavior,” he said. “That’s why this product is so important. When the system only looks at a few things, there are big gaps for a lot of people who function outside that system. This is aimed at filling in those gaps.”

Still, credit counselors like Greenberg see real risks. For example, because some of the 50 million targeted individuals are completely outside the traditional credit system, they aren’t constantly barraged with pre-approved credit offers and come-ons from loan companies, he noted.

When the new scoring system gets underway, that’s likely to change -- which means millions of additional consumers will have the ability to dig themselves deeply into debt.

On the other hand, renters may benefit from the new system because their biggest monthly obligations -- rent and utilities -- now don’t count in traditional credit scores. As a result, even though they may currently qualify for some loans, such as auto loans and credit cards, they often pay more for credit than people with mortgages.

Fair Isaac said its expanded score could mean that people who religiously pay their rent will get as good a credit rating as homeowners who consistently pay their mortgage on time.

“You may not have a credit card, but you have been making your rent payments on time for four years. You actually have a great credit history,” said Dan Drummond, spokesman for Your Credit Card Companies, a Washington-based coalition of major lenders. “Should you be paying 25% for a car loan? No way. The spectrum from which credit will be judged is broader now. That’s probably a good thing.”

Still, “probably” is the operative term, most experts say. That’s because credit data isn’t always reported in the same way. And until the new system is tested, it’s impossible to know whether the new sources of credit data will provide reliable and comprehensive information.

“The devil is in the details,” Plunkett said. “Simply because Fair Isaac says it’s going to use some expanded sources of credit information doesn’t necessarily mean that more Americans are going to get access to credit at reasonable prices.

“If the full range of credit history is reflected, it could be a boon to consumers,” he said. “But if only the negatives are reflected, it could harm consumers.”. Worse, the information could make some consumers “targets of abusive lenders of all stripes,” he said.

Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past columns, visit latimes.com/kristof.