[Editor’s note: This is a guest post from Tom Burnside, CEO of LendingPoint. LendingPoint is a Platinum Sponsor at LendIt USA 2016, which will take place on April 11-12, 2016, in San Francisco. At LendIt Tom Burnside will be speaking on the panel: How Do you Expand Credit to the Thin File?]
Traditional lending is being challenged by the emergence of a new breed of lending. Going to the bank to apply for a loan is quickly becoming a thing of the past. While the process itself has not significantly changed, it is now much easier to get a loan without the inconvenience of applying in person. The challenge for all lenders is to understand the fair-credit consumer with a FICO score of 600-675 looking for an unsecured loan. This fair-credit customer has been left behind by traditional lending models, with no alternative but to utilize payday lenders who can charge APRs from 60 percent to as high as 400 percent. Why do traditional lenders shy away from these consumers?
The answer is simple: their credit story is not easily told or understood. Many of these consumers have low FICOs because they have little to no established credit or they’ve experienced a challenging financial event. Traditional lending approves established credit, because that credit story is easier to understand. So if it’s not established or “good” credit how can you narrate, much less comprehend, a fair-credit story? Typically the less understood consumer is charged a premium for this lack of understanding. The inability to create clarity around the consumer’s risk often results in a decline, or payday lenders price it into the products they offer. This stops traditional lenders from lending and allows payday lenders to charge high APRs.
Sometimes the offset of secured lending allows a lender to go deeper into conventional credit risk, because an asset mitigates the loss severity. It is generally thought that if you approve all consumer applications that will result in 25-30% write offs. The lender’s challenge is to identify – through understanding the consumer’s story with data – the other 70% of customers who will perform. Such an approach will allow new borrowers, as well as borrowers who have encountered financial events, to enter a fairer lending environment. Before we can understand how to look at data, let’s think about the questions we would like to answer. Will the consumer pay back the money? How long are we willing to allow them to pay off their loan? Once these questions are answered, you can grade the risk and price appropriately.
So what data allows us to tell a consumer’s credit story? It starts with an understanding of how the consumer is currently managing their finances. Traditionally, lenders look at credit through a series of questions like DTI (Debt to Income), PTI (Payment to Income), availability (how much credit do they have left?), the number of established creditors, and the consumer’s FICO score. These data points tend to be binary switches, above or below which you are either approved or declined. What these questions do not address are broader, more complex credit considerations. For instance, the consumer may only have one credit card and while the availability may be low, the DTI is low as well. This would indicate that the borrower has the cash flow to handle emergencies. Another consideration is if the consumer is current with other payments, even though they may not have established multiple traditional creditors.
There are many other ways to establish someone’s ability or willingness to pay. Items like utility and cell phone bill payment history, and recent credit applications can indicate more relevant financial trends. Lenders should also know the purpose of the loan request. Is the borrower trying to get out of debt because they’ve overindulged in credit spend or is the purpose to improve an asset they currently own, like a home or vehicle? The answers to all of these questions are available through evaluating both traditional and non-traditional data. Finding meaningful data resources and knowing how to marry traditional and non-traditional data to tell these credit stories is today’s lending challenge. It starts with knowing the relevant questions, finding the data to tell the consumer’s story and then understanding the interaction of these variables.
Technology allows us to capture enormous amounts of information and quickly make a decision. The challenge is to have the right team and technology to stay current with the market and the right products available to consumers at the point of need. The ability to understand current economic conditions and how they impact a consumer’s credit story should always be a consideration. Data can allow the lending market to embrace the borrowers of the future and reestablish borrowers who are on their way back to financial health. Better understanding of this underserved market will create opportunity and growth for lenders both now and in the future. For all lenders, future evolution and customer retention is the key to success in the new marketplace. Today’s lenders would be mistaken if they overlook the fair-credit market, because consumer loyalty will always go to the lender who was there when the consumer needed them.
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