Millions of Americans are invisible to the three major credit reporting agencies in the United States. According to the Consumer Financial Protection Bureau (CFPB), millions more Americans have credit histories that are insufficient to generate a credit score. In total, some 45 million Americans lack the traditional marker of creditworthiness, leaving them with “substantially reduced access to credit.” CFPB’s study focused mainly on personal credit, but small businesses also feel the affects of a weak or poor credit history.
Credit reports make up the foundation of the majority of lending decisions. “Without credit reporting and credit scoring, it would be harder for financial service providers to assess and manage credit risk, and the supply of credit would be more expensive, more erratic, and more constrained,” CFPB Director Richard Cordray said during a call about the research.
Credit score may be the most common factor in lending decisions, but there are alternatives. FICO recently announced a pilot program that will help individuals establish a credit history using utility and other reoccurring payments, the CFPB report notes. Although new in the world of the major three credit bureaus, using alternative data in lending decisions is common in the alternative lending industry. Even as traditional lending methods begin to ease the more stringent requirements put in place after the financial crisis, alternative lending continues to grow. New players are entering the field and recent reports note increased investor interest in alternative financing startups could lift the industry past the $1 trillion mark in the no-so-distant future.
Lenders who go the alternative route when evaluating creditworthiness are seeing success. PayPal Working Capital lends $2 million a day to small businesses across the U.S. The 18-month-old program recently increased borrowing limits to $85,000, and 90 percent of borrowers are repeat customers, according to the company. The loans are approved and funded within minutes and are paid back through a percentage of daily sales. Other lenders such as Jade Funding have found ways to assess the financial health of a business without a credit score.
The CFPB report, which reviewed credit records purchased (with personal identifying details removed) from Equifax, Experian and TransUnion, and data from the U.S. Census found low-income Blacks and Hispanics are more likely to be without a credit score. The Small Business Administration is actively working toward improving funding access to minority business owners. Maria Contreras-Sweet, the organization’s head, outlined a series of new initiatives to extend the SBA’s reach. Plans in the works include incorporating alternative lenders into SBA loan programs and streamlining the application process. Contreras-Sweet also highlighted a Spanish-language version of the SBA’s website targeting Hispanic entrepreneurs.
A damaged or non-existent credit history doesn’t have to prevent a small business from getting the funding they need. From merchant cash advance and peer-to-peer lending to online marketplaces, more than any other time in the past, business owners have options. The CFPB survey shows there is a large underserved market of potential businesses owners who are in need of financial support. As the SBA’s Contreras-Sweet told attendees at the eMerge conference earlier this month, “Everybody’s thinking about starting their own business today.” Access to capital is the No. 1 hurdle small businesses face, removing the extra difficulty of a credit score may be one way to jumpstart small business.