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Study Shows Traditional Credit Scores May Not Be Accurate When Assessing Risk Millennials Pose

commercial-falling-moneyMillennials, which are viewed by many analysts as the key to driving the housing market recovery, are actively seeking credit but largely being denied, according to a white paper released Tuesday by ID Analytics titled "Millennials: High Risk or Untapped Opportunity?"

The three main purposes of the ID Analytics research for the white paper were, one, finding the driving factors behind the low credit participation rates among millennials, which the study defines as individuals born between 1981 and 1996; two, comparing the credit acceptance rates for millennials to other demographics; and three, dispelling the myth that when millennials perform poorly compared with older age demographics with similar credit risk.

The study showed that the first financial products minors often acquire when they move to adulthood are wireless phone services, auto loans, and credit cards. But while the study found that millennials were seeking credit at a higher rate than generation Xers or baby boomers in three categories (bank cards, telecommunications, and marketplace lending), they were being accepted for credit at a much lower rate than either of those two demographics.

Millennials were found to have to have lower credit scores in 80 percent of the categories that make up traditional credit scores such as mortgage loans, auto loans, credit cards, and other installment loan payment histories because many young adults simply do not have any credit history with these financial products, with the exception of student loans. The study determined that those under age 27 are more likely to have a FICO score under 660 than older age groups.

"Since credit scores are used to determine credit worthiness, enterprises that only use traditional credit bureau scores will likely perceive millennials as higher risk applicants," the report stated. "This limited view hinders enterprises from understanding the true opportunity risk of millennial applicants and will often result in credit declines or sub-par offers that are not accepted by the consumer (i.e. higher interest rates, deposit requirements, limited features, etc.)."

To determine if the traditional credit score accurately represents the risk it has attached to millennials, ID Analytics compared that generation's performance to individuals with the same credit scores from older generations. The result was that millennials had a 1 percent "bad rate" (the consumer is more than 12 months late in making a payment) compared with 2 percent for generation Xers and 3 percent for baby boomers, meaning millennials outperformed both of the older generations in this category. The conclusion drawn by ID Analytics is that the traditional credit score is not necessarily accurate in determining the level of risk among the younger generations due to the factors that are used in determining the credit score.

Lenders would have a more accurate assessment of the risk among the millennial demographic if they turned to areas in which younger adults have experience with financial products, according to ID Analytics.

"Millennials want to establish credit and they represent a high lifetime value to lenders," the report said. "There are many millennials that are low risk and provide a profitable opportunity for enterprises to expand their business. The millennials are disproportionately turned down due to traditional credit score calculation that favor consumers with more established credit behavior. Using a score that includes alternative data from wireless providers, marketplace, or other online lenders will not only be more predictive, but also more predictive in the very industries millennials are seeking to start their credit relationships."

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.
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