By Greg Rable
50 million potentially viable loan recipients are being ignored.
National experts agree that a full 20% of U.S. households are underbanked—meaning they have a bank account but also use alternative financial services (AFS) outside of the banking system. But traditional banks often won’t consider these consumers for needed loans, only because the banks aren’t analyzing the right data. As a result, this population is the one that most often seeks out smaller short-term loans for emergency needs. That’s unfortunate for the consumers—and a bit short sighted for banks, which are overlooking a large business opportunity.
Missing the boat.
The historical perception that the underbanked are risky clients has harmed both consumers and lenders alike. I believe that the underbanked are indeed striving for a better financial standing and, as such, deserve more credit options. Consumers who have proven their ability to repay (ATR) on short-term loans have earned access to the money needed for life’s every day emergencies (new tires, ER visits, unexpected plumbing expenses, etc.). Bank marketers are missing the boat, as a result, by not offering loan services to nearly 50 million U.S. consumers who deserve a closer look.
Granted, lenders are continually faced with the challenge of how to efficiently manage risk while lending to the underbanked and the non-prime consumer. New regulations from the Consumer Financial Protection Bureau (CFPB) certainly won’t make it any easier. Under the new proposed rule, for each short-term loan, vehicle title loan, deposit advance product, installment loan and open-end loan, lenders will need to make a “good faith, reasonable determination” of the consumer’s ATR. The lender will not only take into account the consumer’s self-reported income and financial expenses, but turn to resources that will help the lender uncover major financial obligations and borrowing history, validate the reported income and living expense, all while considering a 30-day “cooling off period” between loans.
Knowledge is power: alternative data.
Under these new regulations, knowledge is power. This is where alternative credit data comes into play to help more accurately determine ATR.
Alternative data is a loosely used term that includes both financial data collected from non-traditional lenders, and non-financial payment data, such as public records. Alternative credit data is information derived from alternative loans and it is the most effective way of determining how creditworthy an underbanked consumer can be. And it is an absolute must-have to determine a consumer’s real ATR. More data is better for both the consumer and the lender.
The relationship of debt-to-income and default rate can be more accurately gauged when viewed through the prism of alternative credit data, giving a more accurate picture of a consumer’s true ATR. The most recent FactorTrust Underbanked Index, released in May 2016 and based on expert analysis of alternative credit data from FactorTrust’s database of tens of millions of records, shows insight into the underbanked’s income trends and their ATR.
For example, applicant eligibility changes quite a bit when lenders are able to analyze alternative credit data and consider residual income (a consumer’s income minus debt obligations—both traditional and alternative—housing costs, living expenses, and the loan payment amount plus fees of the covered loan for which they are applying) vs. loan amount. Data shows that 31% of total applicants have sufficient residual income and would not be considered in the proposed cooling off period after considering loan payment amount. However, eligibility could reach as high as 40%, if lenders use alternative credit data to optimize underwriting decisions and dynamically adjust loan amounts, accommodating limited residual income.
The data also revealed that the relationship of debt-to-income and default rate is strengthened when adding alternative credit data to traditional credit data. The reason is that some of the same data elements that are being combined for the first time due to the new ATR rules can be repurposed in adverse action decision making. Lenders who take advantage of blending traditional and alternative credit profiles for underwriting will improve the profitability of their portfolios while still complying with the CFPB’s new rules.
Lenders can trust alternative credit data to approve more loans to underbanked consumers who need them, while maintaining business growth and adhering to the CFPB’s rules.
Credit climbers: the untapped market.
With real ATR in mind for these millions of potential customers, bank marketers need to look closely at attracting the so-called credit climbers, consumers determined to improve credit scores in order to reach a certain lifestyle and access more credit options. Every time a credit climber does something positive, they deserve to improve their credit score. The problem is that the vast majority of these customers—and their credit performance—are simply unrecognized and untracked by the big three bureaus. We’ve seen people improve their credit scores at every scoring level by having alternative credit data factored in during the underwriting process.
From demographics to loan behavior data, alternative credit bureaus provide lenders with a more holistic view of underbanked consumers, consumers that the ‘Big 3’ often miss. There are 113 million U.S. consumers with FICO credit scores under 700 today. They should be recognized as consumers with the potential to improve credit scores in order to reach a certain lifestyle and access more credit options. While alternative credit data might be more difficult to locate, it proves to be extremely predictive of future borrowing behavior. Moreover, that actionable intelligence means smarter business, opening up millions of new customers for banks around the nation.
Greg Rable is founder and CEO of FactorTrust, an alternative credit bureau that uses proven analytics and clean credit information to provide lenders with a more holistic view of underbanked consumers.