What degree of lending risk are you willing to tolerate? You probably ask yourself this daily. Your answer varies with the direction of the market or the health of your business. The oversimplified answer lies somewhere on an economist’s theoretical graph where you maximize profit while minimizing lending risk. You’re trying to hit that sweet spot every time you offer a deal. It’s easy when lending to prime borrowers, but managing risk for other tiers gets complicated as you move into subprime territory.
For decades, credit scores from Experian, Equifax, and TransUnion were the source of credible data to guide lending decisions. With this information, you can still make lending decisions and deal structures for high scores with confidence. Applicants with lower scores require additional time and greater diligence in evaluating lending risk and structuring deals. For many lenders, much of that activity involves underwriter review, verification, and looking for additional information to confidently evaluate risk. Declines are certain, but you’ll also have frequent exceptions, overrides, or conditional approvals. Although you try to achieve consistency in applying credit policies, a great deal of variation remains. Better applicant data and a consistent evaluation process for subprime applicants are needed to reduce variation and lending risk.
Alternative Credit Data for a Detailed Picture of Creditworthiness
Many new data sources are now available to provide a more detailed and accurate picture of an applicant’s financial position. These alternative tradeline data include a wide range of information made available by an increasingly-digitized economy and innovative fintech applications and services.
Although data privacy laws constrain the collection and sharing of personal and confidential information, many consumers agree to share their information because it provides a clearer picture of their creditworthiness. Much of this data has been generated within recent years. Additional sources of data will undoubtedly become available in the near future. Alternative credit data can include:
- Employment history and income data
- Banking information showing relationships and types of accounts
- Real estate ownership
- Records of any bankruptcies, liens, or judgments
- Utility, cable TV, or cell phone records with contact information and payment history
- Rental history and payment records
More companies are using alternative credit data, too. Experian’s 2018 report The State of Alternative Credit Data confirms this. Almost 80 percent of lenders surveyed for the report use FICO scores and at least one alternative credit data source. Sixteen percent indicated that they use or plan to use rental or utility payment records. Overall, lenders believe alternative credit data sources help assess a borrower’s ability to pay, reduce lending risk, and make better quality lending decisions.
Alternative Credit Data for New Lending Opportunities
Millions of U.S. consumers have “thin” credit profiles. Thin credit makes it difficult for lenders to confidently evaluate an applicant’s creditworthiness. Here, alternative credit data can identify previously overlooked lending opportunities. Indicators of stable employment, consistent income, and reliable payment histories available from alternative credit data let you make lending decisions for this market segment with confidence. At the same time, alternative credit data allows you to accurately identify high-risk consumers in this market segment and decline those applications.
Reducing Lending Risk With Alternative Credit Data
Alternative credit data helps reduce lending risk in two ways. First, it allows you to make lending decisions based on detailed, accurate, and current application information. The combination of traditional credit data and alternative credit data can potentially deliver well over a thousand consumer attributes to help you evaluate creditworthiness and structure deals. Just as the wealth of online automotive information empowers consumers to make well-informed auto purchases, the wealth of available consumer information now enables lenders to make better quality lending decisions.
Second, alternative credit data greatly reduces the inherent variation and risk involved in manual underwriting tasks and decisions. A modern loan origination system pre-integrated with alternative credit data sources uses automation to access these data sources. It then consolidates selected data from the sources and formats it to be easily evaluated by decision rules and displayed in a format easily understood by underwriters. Decision rules applied to this consolidated credit data eliminate the need for manual scorecard review and can assess an applicant’s creditworthiness in seconds and apply funding rules to structure a deal. In the event that decision rules determine the application requires further review by an underwriter, the application is automatically assigned to an underwriter’s queue.
The combination of alternative credit data, automation, and decision rules enables a consistent process for quickly delivering data-driven decisions that reduce lending risk.
Lenders also benefit from reduced processing costs and more efficient use of resources to focus on tasks that truly require underwriting expertise.
Analytics to Regularly Evaluate Portfolio Performance
Alternative credit data are valuable resources to help reduce lending risk and identify new lending opportunities. As you incorporate alternative credit data into your underwriting process we recommend a regularly scheduled analysis of portfolio performance. You’ll want to verify that your selection of alternative credit data attributes and the decision rules you’ve established improve your ability to reduce lending risk, reducing delinquencies and defaults.
For example, applicants without FICO scores may perform better (have lower default rates) than low FICO scores. Some segments of “thin” file applicants may be higher-risk than others. Only regular analysis of attributes and loan performance will uncover this. Over time you’ll certainly need to make adjustments as you uncover these correlations.
A Great Opportunity to Learn How to Reduce Lending Risk
Risk is a top-of-mind concern for anyone in the lending industry. In September 2018, defi Summit 2018 will offer a three-day opportunity to surround yourself with lending experts and practitioners. You’ll learn how to reduce lending risk and discuss ways to improve every aspect of the lending lifecycle. Take a look and the agenda and register today.
defi SOLUTIONS is a lending industry leader. Our loan origination solution provides all the capabilities you need to realize the full benefits of alternative credit data—pre-integrated access to data sources, configurable decision rules, automation, and analytics. 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 reducing lending risk by contacting our team today or registering for a FREE demo.