What Is Alternative Data and How Does It Affect Credit Scores?
Your credit score is an important piece of financial information that tells lenders how well you manage money. FICO scores, used by 90% of top lenders in the U.S., have traditionally been based on five distinct factors. But FICO and other credit scoring models are increasingly looking to alternative data to help generate consumer credit scores.
RELATED: Breaking Down the FICO Credit Scoring Formula
How Credit Scores Are Calculated
Traditional credit scores are based on information that comes from your credit reports. FICO scores, for example, break down like this:
- Payment history – 35% of your score
- Credit utilization – 30% of your score
- Credit age – 15% of your score
- Credit mix – 10% of your score
- Inquiries for credit – 10% of your score
Lenders and creditors report things like on-time payments, late payments, applications for new credit and account balances. Those details are then used to formulate your credit scores.
Alternative data, on the other hand, introduces some new factors in the mix for credit score calculations.
RELATED: What Credit Score Is Needed for a Personal Loan?
What Is Alternative Data?
In simple terms, alternative data is anything other than the five factors outlined above that could be used to calculate your credit score.
For example, credit scoring models that use alternative data can take into account things like:
- Rent payments
- Utility bill payments
- Cell phone bill payments
- Other bill payments, such as child care or monthly subscription services
- Bank account information
Incorporating alternative data into credit scoring models represents a break from the way things have traditionally been done. But that could be a good thing if you’ve struggled to get a loan or credit card because of a poor or thin credit history.
RELATED: What Is a Thin Credit File?
Alternative data can help to create a more comprehensive picture of how responsible someone is financially, beyond their account activity for loans or credit cards. If you’ve never had a credit card or loan in your name, for instance, you may not have enough credit history to generate a credit score.
But if you’ve always paid your household bills on time and you have a little savings in the bank, those things could help you establish a credit score with a model that uses alternative data. That can make it easier to gain a toehold for building credit so you can eventually get loans or credit cards in your name.
RELATED: Emergency Loans – How to Borrow Money Fast
How Alternative Data Affects Credit Scores
The key thing to remember about alternative data is that not all credit scoring models use it.
For example, the UltraFICO model focuses specifically on alternative data to help establish credit scores for people who may otherwise be credit invisibles. And while FICO 9 allows for the inclusion of rent payments for score calculations when that information is available, FICO 8 doesn’t consider rental history.
But generally, having alternative data included in your credit score calculations could work in your favor if you had a steady payment history. Remember that with traditional FICO score models, the most important factor is payment history. Paying credit cards, loans and other debts on time can help your score, while paying late can cost you major points.
If you don’t have any of those accounts but you do have a history of paying all your other bills on time, that could make you appear less risky in the eyes of lenders. And if you already have a credit history and score established, alternative data could only help to strengthen your score even more.
How to Improve Your Credit Score
While alternative data is becoming more popular in credit scoring circles, not all scoring models use it and not all lenders consider it when you apply for loans or lines of credit. If you want to raise your credit score, these tips can help.
Get in the habit of paying on time
Paying bills on time is one of the smartest financial habits to develop. Not only can paying on time help your credit score, it can also save you money if you’re avoiding late payment fees.
If you struggle with paying on time, consider automating bill payments. Or you can set up bill payment alerts to help you stay on top of due dates.
Consider a secured credit card
Secured credit cards can help you establish credit if you have none or repair bad credit. These cards typically require a cash deposit to open, but you can use them to build credit with timely payments.
Pay attention to the card’s APR and fees, as well as whether your deposit is refundable. And make sure the card issuer reports your account activity to the major credit bureaus.
Take out a small personal loan
Personal loans are another way to build credit. Getting a small loan that you can repay in a few months can help you establish a positive payment history and credit score.
When looking for a personal loan, compare different lenders first. Look at the interest rates, fees and repayment terms to find a loan that fits your needs and budget.
RELATED: Personal Loan APR vs Interest Rate: Why You Need to Know the Difference
How to Use Personal Loans
From how to use personal loans to ways they can help you to pay off debt and more.
Rebecca Lake is a freelance writer specializing in personal finance,
credit and debt. She’s a contributor to U.S. News and World Report,
Forbes Advisor and The Balance and her work has appeared online at CreditCards.com,
Money-Rates.com and dozens of other top publications.