Could Your Friends Ruin Your Credit?

Yesterday, I was browsing CNN at work and came across this catchy title, "Facebook Friends Could Change Your Credit Score." I immediately click the link and what I read bothered me.

From Facbook.com

The article explains that some alternative lenders are using social media to determine creditworthiness. Katie Lobosco, the author writes:

"Some financial lending companies have found that social connections can be a good indicator of a person's creditworthiness."

She mentions two companies, Lendio and Kreditech, who are currently using the system with success.

 "It turns out humans are really good at knowing who is trustworthy and reliable in their community," said Jeff Stewart, a co-founder and CEO of Lenddo. "What's new is that we're now able to measure through massive computing power."

As someone in the lending industry, I think this is a terrible idea.  While there may be some evidence that we surround ourselves with people who share our values, using social media to determine creditworthiness is like swiss cheese, filled with holes.

First, my generation, the millennial, has a tendency to "friend" everyone and anyone. Meet a person in a bar, let's friend them in the morning. Have a high school friend that you haven't talk to in 10 years, can't hurt to ask for a friend request. This kid in Tokyo likes the same comics as I do, we need to be friends. College students are notorious for friending complete strangers that go to their campus. A friend request or adding one to someone's circle (Google +) does not mean that I know this person well.  Honestly, I couldn't tell you the financial status of over 95% of my friends on facebook, nor do I care.

Second, the use of friends' creditworthiness in determining someone else creditworthiness will result in many wrong decisions. I believe that more often than not people will be judge incorrectly. For example, subject A grew up in a low income neighborhood with high unemployment. Most of his friends on Facebook are from his old neighborhood. He has worked 2 jobs since 16 to save enough money to pay for college. Under this friend scheme, my gut is that subject A will be declined for the loan. On the flip side, subject B goes to Harvard and his friends on Facebook skew highly from college. Subject B's family has poor money skills. My guess is that Subject B will be approved for his loan request.

Similarly, can't one game the system by adding friends with good credit like subject B. I could see a whole industry starting where people offer themselves as "friends" in exchange for money. The ability to game the system destroy's its credibility. Credit scores are very difficult to game. Not impossible, but very difficult. 

I am not alone in my feelings:

"Some in the financial industry are skeptical about social data and online behavior being used as a kind of credit score. John Ulzheimer, a credit expert at CreditSesame.com, says social data aren't necessarily indicative of whether the borrower will pay back a loan on time. FICO only considers a handful of factors, but they are all "incredibly predictive of risk," Ulzheimer said.

There's also the potential to game the system. Consumers can easily control how many Facebook friends they have and tweets they write. The same cannot be said for what goes into their credit score.

"To me, using social media is a little bit dangerous," Ulzheimer said"

Finally, this system can lead to massive discrimination. Credit scores are color/sexual orientation/martial status bind. Yes, loan officers/underwriters can still discriminate against borrowers. However, the major deciding factor is quantitatively driven. This social model is quantitatively driven. A loan officer is making a decisions on someone application based upon pictures, stats, tweets, and likes. You can obviously imagine scenarios where loan applications are declined, because of the applicant having to many friends that wear baggy clothes or green picky hair, supporting gay rights or tweeting the lyrics of a rap song. What does tweeting the lyrics of a rap song have to do with creditworthiness? President Obama has used rap lyrics in speeches, is he not worthy of credit?

I hope that social media/friend credit model does not come to the United States. Currently, this model is used in Mexico, Russia, Czech Republic, and Philippines. This model is rip for abuse and for that reason, we need to pass. Social media should be used for that, social purposes. 

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