Thin Credit Files Are Not Sexy
What’s a thin credit file?
In the personal finance realm, if you have a small amount of traditional credit information, such as credit cards and loans, you have what the industry refers to as a “thin” credit file. The term refers to a file of credit information (whether that file is a paper folder or, more likely these days, an electronic file) that contains very little data about your use of credit, most likely because there isn’t a long history of credit use upon which to judge you.
Thin file syndrome affects people who have not made many credit applications in the past decade, young adults just starting their careers, recently divorced or widowed individuals with little or no credit in their own name, newly arrived immigrants and people returning after living abroad, and people who shun the traditional banking system by choice. Those over 60 are also likely to have thinner files - as are the wealthy, whose use of credit may be rare.
According to the credit industry veterans and consultants, if you have only two accounts or just two credit cards you have a “thin” credit file. It is recommended that you keep at least three open and active accounts that have existed for at least three years. Active means activity has occurred within the past 6 months.
Nearly 18 million Americans have files too thin to produce a credit score, and another 17 million have no files at all, according to Experian. This results in a significant number of people who may be blocked from credit or incorrectly priced because lenders are unable to use their standard decision-making strategies.
In the past, this would have prevented you from getting credit, even if you paid all your bills on time and had a substantial amount of money in savings. Because it is difficult to assess the creditworthiness of thin file consumers, mainstream lenders largely ignore this vast category of potential consumers (or have had to default to costly manual underwriting processes), despite the likelihood that many would prove to be low-risk consumers. Sensing an opportunity within this underserved market, the credit industry has become very proactive in expanding credit models and allowing increased lender penetration into the minority and new-immigrant population sectors.
A thin credit file results in higher interest rates
Without much information in your credit file, you can’t check your credit score and lenders are similarly unable to obtain it, which is a numerical representation of your credit history. You may end up paying “subprime” rates because your limited credit history makes you appear high-risk when lenders use traditional FICO scores. Lenders can’t review your past use of credit to judge whether you are likely to repay the loan, which makes the loan riskier for the lender. You are thus likely to be charged a higher interest rate and higher costs to compensate the lender for the additional (perceived) risk, if you’re able to get credit at all, that is.
A thin credit file weakens your score
If you only have a two-account or “thin” credit history you may be at a serious disadvantage if something negative were to happen that is reported to your file, it could impact your score in a big way. One 30-day late payment might knock the score down 50 points.
Depending on how long your two existing accounts have been open, the damage from a single late payment may be more or less severe. If the accounts were less than a year old the overall picture would be worse than if both accounts were over five years old or more. Similarly, if you have more than two accounts, the overall effect would be less severe.
Strategies to strengthen your credit file
You don’t need major credit accounts like a credit-card, car loan or mortgage to establish a minimal credit history. Instead, you can get started with an installment loan from a jewelry, furniture or electronic store; a department store or gas station charge card; a gym membership or even a cell phone account that’s paid monthly. After that, a car loan or a credit-card is a good way to fatten your credit file.
If you have open credit accounts that you use only infrequently, you can strengthen your credit by using those accounts more often to establish a pattern of borrowing money and paying your debts. A mix of different types of credit (e.g., a credit-card and a car loan) can also help to strengthen your credit history.
It’s important to use credit responsibly throughout your lifetime. Never borrow more than you can afford to repay even if you want to improve your credit score. Unpaid debts don’t result in better credit, and bad credit is much more onerous and burdensome than thin credit.
Other options for thin credit borrowers
Anthem, developed by First American CREDCO, the credit data subsidiary of Santa Ana, Calif.-based First American Corp., evaluates whatever information on an applicant may exist in the files of national bureaus Equifax, Experian and TransUnion. Then it mixes in information collected by CREDCO from other sources such as regular child-care payments, telephone, electricity and other utilities payments, current and former rent payments, plus personal credit data from businesses that do not report to the bureaus — small local retailers that extend credit, payday lenders, rent-to-own companies and the like.
This produces an alternative credit file that can then be scored. First American CREDCO says their scores accurately predict borrowers’ risk of future default. Better yet, alternative scoring allows lenders to cut mortgage rates, down payments and fees for people with solid — albeit nontraditional — credit backgrounds.
The goal is to help “deserving families to secure prime-grade mortgage loans,” in spite of the fact they score poorly using traditional FICOs.
The Anthem system is just one of several alternatives that are now available to help “thin file” applicants. Fair Isaac itself offers an alternative-data counterpart to its traditional FICO score that is known as the Expansion score. The 3 major credit bureaus have also developed the VantageScore in an effort to “provide credit grantors with a reliable, predictive scoring solution with the decisioning insight required to extend credit with confidence to a greater percentage of thin file customers”
Another company is functioning as a national repository for nontraditional credit data. Annapolis, Md.-based PRBC.com specializes in helping consumers build their own alternative credit databases by supplying verifiable rent, utilities and other periodic payment information directly to the firm.
PRBC (Payment Reporting Builds Credit) is a national consumer reporting agency and credit bureau. PRBC collects, stores, scores and reports bill payment data for “permissible purposes” under the Fair Credit Reporting Act. It is the first credit bureau to give consumers and small businesses a way to build a credit file to demonstrate creditworthiness without the need to go into debt.
People who have thin credit now have more options to further facilitate access to credit. They can have a co-signer who has a strong credit history and who agrees to also be responsible for the loan. Another option is to make a very large down payment, which reduces the lender’s risk. A steady paycheck and other assets such as a retirement savings account can be helpful as well.
~
Thin credit file bottom line: a lack of sufficient credit information to produce a traditional credit score in the big three credit bureaus no longer means that you can’t have access to credit on favorable terms. You just need to ask about — or demand — scoring alternatives from lenders that give you a fairer shot.
Leave a Reply