Alternative Credit Scoring Models: Beyond FICO

Conforming to standards isn’t always easy or clear cut—just ask the many individuals whose credit scores prevent them from getting personal loans, mortgages and credit cards every year. According to Bankrate, about seven in 10 applicants with “poor” credit (based on FICO’s ratings) have been denied at least one loan or financial product since 2022. So, in October of that year, the Federal Housing Finance Agency approved two new credit scoring models: the FICO Score 10 T and VantageScore 4.0. 

The first model uses a new set of “predictive characteristics” based on traditional and trended credit bureau data, which would help educate lenders on potential future outcomes. The latter considers consumer credit behavior over a period of time, instead of a simple snapshot. 

ICBA and other industry groups have expressed concern over the lack of transparency and data that went into developing these two models, but policymakers ultimately decided that both models would be used for all mortgage loans sold to Fannie Mae and Freddie Mac. 

Community banks already expand access to banking

Michael Emancipator, SVP and senior regulatory counsel for ICBA, says using alternative data to determine an applicant’s ability to pay back a financial obligation isn’t necessarily new. In 2015, for example, a Consumer Financial Protection Bureau (CFPB) report shined a light on the 26 million Americans who are “credit invisible” and have no credit history with any of the three major credit reporting companies (Experian, Equifax and TransUnion).

Emancipator says if “underbanked” individuals are included with the “unbanked,” the credit invisible market covers about 65 million people. Community banks are well-positioned to serve this customer base, which would otherwise be dismissed or ignored due to their credit history, or lack thereof. 

“It’s a fairly sizable market,” says Emancipator. “By their very nature, community banks have the relationships with their communities to know how much of their area is underbanked. They know where the opportunities are.” Community banks may also be more apt to use creative ways of qualifying applicants and approving loans that may be quickly rejected by larger institutions.

Take $446 million-asset Spring Bank, for example. The Bronx, N.Y., community bank has long prided itself on serving customers who don’t generally qualify for standard loans and financial support. 

Spring Bank has been making small-dollar loans in the $1,000 to $3,500 range since 2016. The bank is a registered B Corp that has received support from the U.S. Department of Treasury’s Community Development Financial Institutions (CDFI) Fund, which helps promote access to capital and local economic growth in urban and rural low-income areas.

Spring Bank also goes deeper by encouraging good savings habits as part of its Employee Opportunity Loan Program, which it runs in partnership with 38 employers in New York City and Westchester County. Introduced in 2017, the Opportunity Loan component of the program is designed for employees who have worked for a company for at least 12 months and earn a minimum of $20,000 annually. The bank uses employment—not a FICO score—to make its Opportunity Loan lending decisions. Spring Bank partnered with fintech Happy Mango Credit to develop a user-friendly online application platform that includes drop-down menus for each participating employer, who then validates the individual’s employment status and income. 

The bank benefits, too

Spring Bank has made about $8.5 million in loans since introducing the program, which Melanie Stern, VP, Community Reinvestment Act officer and director of consumer lending, calls “extremely successful.” In fact, she says the total losses on these uncollateralized loans has been less then 5%. “That’s pretty good for these types of loans,” Stern adds. The loan payments come out of payroll and are deposited into a Spring Bank savings account. 

For Spring Bank, the benefits of using alternative loan decision sources extend beyond doling out small-dollar loans to individuals. Borrowers are also encouraged to add a little something to their savings accounts as part of the process—a major “win” at a time when 44% of Americans have less than $1,000 in emergency savings, according to BankRate.

The community bank only pulls the total payment amount from the borrower’s account and leaves the rest of the money to build and accrue interest. “Borrowers can opt to add zero additional dollars in savings if they want,” Stern explains, “but someone who adds just $25 twice a month will have $600 saved within 12 months, plus interest, of course. This behavioral component gives people both a reminder and an easy way to save.”

Employers also gain benefits from the loan program, which helps “boost people’s sense of their employer caring about them,” says Stern. “When people are financially stressed, it can affect their productivity and general well-being at work. That’s why employers are the conduit for this program, and why we get out there and talk to them about how happy people are that their employer is offering this product.”

Safety and soundness risk considerations

As with any type of lending, certain risks need to be considered when using an alternative credit score to determine an applicant’s ability to pay back a loan. Apart from consumer protection risk, Emancipator says banks should use the “typical safety and soundness risks” of explaining your motivations to a board of directors or examiners who want to understand the potential credit risks. 

“The main question is, are you going to get paid back if you use these alternative credit scoring models?” Emancipator points out. “A good way to mitigate that risk is to possibly not necessarily lend on large-ticket items, such as mortgages or auto loans, using alternative credit solely or exclusively.”

In cases where alternative credit modeling is the best option, Emancipator adds that it may be in the bank’s best interest to extend smaller lines of credit—say $500 versus $20,000—and then increase that ceiling as the customer pays back the obligation over time. In other words, start small to keep risk lower at the outset and allow the customers to build their credit and qualify for a potentially higher loan or line of credit.  

This type of lending may require more work, time and due diligence on the bank’s part, but the returns will be worth the trouble, according to Gopal Swamy, CEO at Conductiv Inc., an ICBA ThinkTECH Accelerator graduate that collects data and provides AI‑driven insights to support existing underwriting practices.

“When word gets out that you’re making loans that other institutions won’t make, it can quickly become an organic customer acquisition model as everyone tells their friends,” says Swamy, adding that such lending can also support a bank’s corporate social responsibility commitment. “When they go to their community bank and see that these loans are being made, they’re happy to be customers of that bank that’s doing the right thing.”