The true value of gathering and storing data from an ever-increasing number of sources is our ability to gain insight from that data and use it to improve business outcomes. In addition to the credit bureau data we’ve come to depend upon, there are other sources of consumer information that are collected, aggregated, and made available to lenders. This is not a new notion, but the data’s availability as a result of digital technology makes it all the more valuable and reliable. These alternative credit data sources give lenders the ability to identify new lending opportunities, make better-informed lending decisions, and improve overall portfolio performance.
Credit Bureau Data
Data from the big three credit bureaus—Experian, Equifax, and TransUnion—are the most efficient means to assess creditworthiness for applicants with super prime and deep subprime scores. You might have immediate, automatic approval for high scores and auto-declines for low ones. However, evaluating near-prime and subprime applicants may not be as straightforward. To make better quality (reduced risk) lending decisions for applicants who fall into those categories, you need a more detailed and accurate picture of the applicant. This is where alternative credit data can fill in the missing pieces of the puzzle, so that you can extend credit while maintaining an acceptable level of risk.
Alternative Credit Data Fills in the Missing Pieces
We can thank credit advances in technology over the past decade—near universal connectivity, cloud, low-cost storage, wireless, and mobile applications—for the creation of alternative credit data. The ability to capture, organize, and retain a wide range of transactional data creates an increasingly detailed picture of individual consumers. Of course, there is concern for data privacy and the ever-present threat of security breaches, but we’ll address that issue in a future article. Alternative credit data complements the information provided by the Big 3 credit reporting agencies. It can include information such as:
- Driver’s license and driving records;
- Employment and income;
- Real estate ownership and liens;
- Bank accounts, bankruptcies;
- Utility payment records – electricity, gas, water, mobile phone; and
- Rental records – location, length of lease, payment history.
For applicants whose credit scores lie in the near-prime and sub-prime, the combination of traditional credit score and alternative credit data provides lenders a more detailed picture of applicant creditworthiness. Based on this complementary information, a lender can then assess risk level and make more confident lending decisions. Better decisioning results in better loan structures for applicants you may have otherwise declined, based solely on traditional credit score.
Loan origination systems integrated with alternative credit data sources and incorporating automation and decision rules in the underwriting process achieve the greatest efficiency in evaluating creditworthiness. The combination of credit scoring and alternative credit data gives you greater confidence in lending decisions and loan structuring.
Applicants with Thin Credit Files
According to estimates in the 2015 FDIC National Survey of Unbanked and Underbanked Households (set to be updated this year), approximately 7.0 percent of (or 9 million) US households were unbanked. And 19.9 percent of (or 24.5 million) households were underbanked (households with a checking or savings account who also use non-banking financial products and services).
Individuals in these groups typically have thin or non-existent credit profiles. A thin credit record makes it difficult for lenders to confidently evaluate an applicant’s creditworthiness. Here, alternative credit data can identify previously overlooked lending opportunities.
Applicants who have little to no credit history, but who do have steady employment, consistent or increasing income, address stability, and reliable payment history verified through alternative credit data present new opportunities to grow your loan portfolio without increasing credit risk.
At first glance evaluation of alternative credit data may seem more complicated than straightforward credit scoring. However, a modern loan origination solution eliminates that complexity by handling it all automatically: Alternative credit data sources, automatic access to the sources during the underwriting process, and decision rules to evaluate creditworthiness according to your credit policies and to make appropriate deal structure recommendations. In instances of borderline creditworthiness, decision rules delegate responsibility to an experienced underwriter to make the final decision.
Richer Data Set to Analyze for Improved Portfolio Performance
Alternative credit data that creates a more detailed borrower profile also gives lenders a significantly richer set of loan performance data to analyze. By applying analytics to segments of your loan portfolio that include alternative credit data, you can discover correlations that affect portfolio performance. Then you can apply that insight to fine-tune credit policies to grow the portfolio or improve its performance.
If credit policies have been relatively conservative and you want to increase approval rates while controlling risk, look for borrowers’ alternative credit data attributes that are highly predictive of the ability to pay. Then, give greater weight to those attributes in evaluating creditworthiness during the underwriting process. This can reveal some opportunities. In fact, many no-hit bureaus and no-FICO score customers perform better than those with low FICO scores. For example, many no-hits will perform like 530 FICOs (i.e. ~30% default rate), whereas those with a hit < 500 will have default rates closer to 40%.
However, many of the no-hits that show up in alternative data sources are substantially higher risks than others, showing default rates above 50%. Data is the key to determining the difference between those applicants and creditworthy no-hits. Lenders can use alternative data to get more competitive applicants than some no-hits, and protect themselves against other applicants with substantially higher default rates.
A focused portfolio analysis using alternative credit data may also reveal unexpected correlations, positive and negative, allowing you to modify credit policies to improve portfolio performance. Without access to alternative credit data and analysis, you’re denying yourself lending opportunities and the ability to improve policies to compete successfully.
Alternative Credit Data Equals New Opportunity
Alternative credit data expands lending opportunities by responsibly extending credit to a wider group of borrowers. Whether combined with traditional credit bureau scores or used alone, it provides a more holistic picture of applicants’ creditworthiness. It allows lenders to make better quality decisions and structure loans to match borrower qualifications without assuming undue risk. Alternative credit data is essential in identifying creditworthy individuals who would otherwise be denied the opportunity to participate in the credit market.
Modern lending systems fully utilize alternative credit data, making the information easy to access via pre-integration with these data sources. Decision rules and automation use these data to efficiently and predictably evaluate creditworthiness or delegate credit decisions to an experienced underwriter when necessary. Additional value can be obtained from alternative credit data by applying analytics to identify previously unrecognized correlations that influence borrower behavior and portfolio performance. In essence, alternative credit data equals new lending opportunities.
defi SOLUTIONS is a lending industry leader. Our loan origination and analytic software enables lenders to realize the full benefits of alternative credit data. We welcome the opportunity to discuss your specific business requirements. When it comes to the lending process, we understand the challenges of being successful in a very competitive market. We invite you to take the first step toward greater lending process efficiency and profit by contacting our team today or register for a FREE demo.