EVERY TIME YOU visit a website, you leave behind a trail of information, including seemingly innocuous data, like whether you use an Android or Apple device. And while that might feel like a mere personal preference, it turns out that lenders can use that type of passive signal to help predict whether you’ll default. In fact, new research suggests that those signals can predict consumer behavior as accurately as traditional credit scores. That could disrupt the traditional credit bureau industry that’s dominated since the 1980s—and have serious ramifications for privacy.
In a new working paper from The National Bureau of Economic Research, a team of researchers analyzed over 270,000 purchases from October 2015 to December 2016 on a German e-commerce website that allows customers to buy furniture and pay for it later. (Think of it as Germany’s version of Wayfair.) The store was of particular interest because it already uses a digital footprint, in conjunction with a user’s German credit score, to decide whether buyers qualify for a loan. At least a handful of European retailers have been using similar systems for several years.
The use of a largely outdated email service—like Hotmail or Yahoo—was also an indicator of a higher default rate.
The researchers looked at 10 different types of information customers passively provide, including things like what type of device they used, their operating system, how they got to the site (like whether they clicked on an ad), the time of day they made the purchase, and what kind of email provider they use. The researchers didn’t take into account some factors the retailer normally does, like whether the person has paid a loan back from the same company in the past. Still, they found that those simple variables could be used to estimate whether someone might default, just like a FICO score does.
The difference in default rates between iOS and Android users, for instance, was equivalent to the difference between a median FICO score and the 80th percentile of FICO scores. On one level, these types of insights are intuitive: The average iPhone is much more expensive than the average Android device, and previous research has shown whether someone owns an iOS device is one of the best predictors of whether they’re in the top 25 percent of earners.
The study’s other findings, though, are more subtle. For example, customers who placed orders through cell phones rather than desktop computers were also more likely to default. The use of a largely outdated email service—like Hotmail or Yahoo—was also an indicator of a higher default rate. Customers who incorrectly entered their email address defaulted 5.09 percent of the time; those who didn’t were at .94 percent. In this case, “defaulting” means the loan was sold to a collections agency, usually several months after the purchase and after the customer had been notified three times about their outstanding bill.
Even how you arrive at an e-commerce website can be used to predict whether you’ll default. Those coming in from a price-comparison website were half as likely to default as those who clicked on a targeted ad. That makes sense; savvy, careful consumers browse different retailers’ prices before making a purchase. But even seemingly irrelevant information can say more about your spending behavior than you might expect. For example, customers who have their first or last names in their email addresses were 30 percent less likely to default than those who used something like “cutie367.”
The researchers ultimately found that digital footprints equaled or exceeded the predictive power of traditional FICO-like credit scores, and could even be used to predict how a person’s FICO score might change in future. The authors say digital data could also potentially be used to assess customers outside of the traditional banking system, who often don’t have FICO scores.
But they also acknowledge that wide use of digital footprints for creditworthiness would likely have serious implications for user behavior and freedom online. Imagine buying an iPhone to qualify for a mortgage, or thinking about car loans when signing up for an email account. Customers fudging their digital footprints could also cause lenders to issue loans to customers that can’t actually pay them back.
“My personal opinion is that among most people, if you have someone who thinks about these types of issues, you’re already talking about people who are financially quite sophisticated,” says Tobias Berg, the study’s lead author and an associate professor at Frankfurt School of Finance & Management. He also points out that most consumers in Germany aren’t aware that information like what type of device they use is sometimes factored into loan approvals, even though it’s explained in retailers’ terms of service agreements. “Almost no one reads that, and no one really understands what it literally means,” he says.
Another concern is that digital footprints might serve as proxies for variables lenders are prohibited by law from taking into account, like race. There are clearly people who “are going to be disadvantaged by these digital footprints, no doubt about it,” says Berg. That includes individuals inadvertently categorized as risky, even when they’re not; plenty of people can afford iPhones but go with Android instead. And there are perfectly valid privacy reasons to leave your name out of your email address, for example.
Berg and his coauthors found some correlation between FICO scores and digital footprints but not much; someone’s FICO score might indicate that they’re qualified for a loan, while their digital footprint says otherwise. Berg accounts for the difference by pointing out that credit scores are fairly crude, and only account for extreme situations like when a customer misses a payment. Digital footprints can reveal more psychologically oriented traits, like how someone thinks about making a purchase or what time of the day they shop.
That’s why the researchers suggest the strongest signal comes from combining the two. But for an unbanked person with only a digital footprint, that disparity might result in being denied a loan they would otherwise get.
Not on the Horizon
The good news is that in the United States, digital-footprint loans are likely a long ways off, in part because companies have found in the past that online information may not be as useful as it seems. “We’ve heard this before. The last iteration was social media; companies saying that they’re going to use your Facebook posts to judge how creditworthy you are,” says Liz Weston, a columnist at NerdWallet and the author of five books, including Your Credit Score. “This stuff sounds scary, but a lot of things don’t affect your credit score now and they’re not likely to in the future.”
That’s partly because the lending industry moves incredibly slowly, and is reluctant to change its methods. “The basic scoring formula has worked pretty well and continues to work pretty well,” says Weston. “I just can’t see it being displaced, and certainly not overnight.” That’s not to say it works perfectly; Weston notes FICO puts minority groups that depend more on cash or informal lending at a disadvantage.
Digital footprints, meanwhile, do come into play somewhat in the US; online retailers have used some of that info to manipulate prices for years.
For now, the general behaviors you need to create good credit aren’t based on whims, like whether you kept your goofy email address from high school. But you can’t predict how websites will analyze and use passive data in the future, especially given how hard it is to avoid disclosing information like what kind of phone you have to a retailer. At the very least, though, you can understand how that information is analyzed—and what conclusions companies draw from it.