Hiding in Plain Sight: the Issue of Credit Invisibility in America
The Consumer Financial Protection Bureau recently released a follow up to its 2015 study on credit invisibility in the United States. A person is “credit invisible” when they lack the data needed to calculate a credit score (invisible) or their credit data is so old that it is no longer a reliable indicator of creditworthiness (unscorable). Credit score can be a strong factor in determining whether or not a person secures a conventional loan.
The CFPB’s original 2015 study found that 20% of American adults are credit invisible or unscorable, including more than 20 million middle-income consumers. Young adults and retirement-age consumers are especially susceptible to credit invisibility, albeit for different reasons. Eighteen to19 year olds tend to have little to no credit-affecting activity to their name, while older Americans are more likely to have paid off mortgages and car loans years ago leaving little current credit data to compile a reliable score. As the CFPB notes in the study, “consumers with limited credit histories can face substantially reduced access to credit.”
In hopes of understanding the reasons behind credit invisibility, CFPB returned to the subject this year and explored the various ways that consumers achieve credit visibility. Their research identifies a significant divide– higher income consumers amass credit scoring data through the use of credit cards or through help from another person (like a parent co-signing the loan on their child’s first car), but lower income consumers develop visibility through negative credit records such as debt collection. The gulf in credit visibility practices is stark; customers in lower income areas are 240% more likely to become credit visible due to negative records.
Even when subprime and lower income consumers are able to secure a credit card, bank practices might actually perpetuate a cycle of poor credit that ultimately is passed on to the card holder’s children. Credit card holders with poor credit are often provided lower caps on card usage, and caps have shrunk more than $1,000 on average since 2010. Smaller caps on spending mean a consumer is more likely to max out or come close to their credit limit each month. One measurement taken when calculating credit score is the consumer’s ratio of available credit vs. what is actually utilized each month. This can account for as much as 30% of a person’s FICO score. Essentially, it is better to spend $2,000 each month if you have a $15,000 limit than to spend $1,000 each month if you only have a $1,000 limit, even if you pay the credit card bill in full, on time every month.
Student loans are also increasingly becoming a common way in which Americans become credit visible. The CFPB found that the amount of consumers initiating credit visibility via student loans doubled in the past 10 years. American student loan debt now totals more than $1.4 trillion and continues to grow, so there is no expectation that credit visibility via student loan debt will shrink anytime soon.
Few solutions have been put forth thus far to curb negative credit visibility events and promote healthier credit building, especially in lower income areas. In many ways, alternative financial services have ascended to fill the gap between credit needs and availability. Small dollar lending is poised to continue growing in the coming decades to meet the needs of the underbanked and credit invisible.