Predicting Default Rates for Online Lending

Clarity Services

According to data from Experian’s Clarity Services, online consumer lending has grown over 350 percent from 2013 to 2017. Funded single-pay volume rose 72 percent while installment loan volume went up nearly 500 percent. The single-pay loan volume actually shot up 106 percent through 2016 but fell slightly the following year. Still, these numbers indicate […]

Clarity Services

According to data from Experian’s Clarity Services, online consumer lending has grown over 350 percent from 2013 to 2017. Funded single-pay volume rose 72 percent while installment loan volume went up nearly 500 percent. The single-pay loan volume actually shot up 106 percent through 2016 but fell slightly the following year. Still, these numbers indicate a growth in online alternative finance lending, and with governments around the world cracking down on traditional payday lending, this spells a huge opportunity for further growth in the years to come.

In 2013, the average online installment loan amount was just below $800. In 2017, it was just over $1,400. And the average loan term rose from six months in 2013 to almost 10 months in 2017.

This growth may have something to do with how online installment loan providers are marketing their services. The number of lenders using direct marketing in 2015 was indexed to 100, but in 2018 (through July), that number was 275, representing growth on pace to reach 550 percent by year end. The number of pre-screened mailed names went up from an indexed amount of 100 in 2015 to 988 through July of this year.

Marketing isn’t the only factor affecting growth in this segment of online lending. There is also a growing number of lenders tapping into the market, and the fact that the Consumer Financial Protection Bureau (CFPB), several U.S. states, the United Kingdom, and other government entities are beginning to target traditional brick-and-mortar payday lenders is contributing to the growth of the online installment loan segment.

The growth of this segment highlights the importance of credit risk evaluation. The need for effective credit risk solutions that identify potential defaulters and is capable of separating the good borrowers from the bad is also growing.

The Importance of Predicting Defaults Before Issuing Online Loans

One of the most important tasks for any lender is predicting the likelihood of default. A higher than expected default rate can lead to huge losses. On the other hand, mitigating delinquencies can lead to greater profits and allow the lender to issue more loans. It is particularly important to predict whether a borrower will default on the first payment of an installment loan. After all, defaulting on the first installment means the lender will not recoup any of its investment, and defaulting on the first payment is a clear sign that the borrower should have been flagged as a high credit risk and will likely default on subsequent payments.

Alternative finance lending is inherently risky. Lenders must fight a higher default rate than banks (20 percent vs. 3 percent) right off the bat. That alone makes predictive credit risk modeling a necessity in today’s installment loan market.

In recent years, online lending leaders have seen greater than expected default rates, which means these online providers must be extra diligent about predicting delinquencies in order to watch their bottom lines. For this reason, the tools that lenders use to make such predictions must be carefully chosen so that default rates decline and profits increase over time.

3 Ways to Identify Good Credit Risks Before Issuing a Loan

Some defaults are to be expected. Profitable lenders understand that the interest on the good loans will pay for the losses on the bad loans. Nevertheless, mitigating those losses is paramount to maintaining solvency and being able to service future borrowers. An online installment loan lender can use credit risk scoring to decrease default rates and increase profits simply by identifying the good and bad credit risks. Here are three ways a lender can ensure they are focusing on the good credit risks:

  1. Prescreen your potential borrowers – Credit risk evaluation should begin before you make initial contact with potential borrowers. If you are involved in direct marketing, prescreen potential borrowers before sending them your marketing collateral. Not only can this lower your default rate, but it will also lower your marketing expenses.
  2. Use an effective credit risk scoring solution – Today’s lenders do not just rely on FICO scores and payment histories. They collect alternative data that identifies how potential borrowers spend their money and handle their debts. Much of this data is out of sight from traditional credit scoring agencies, but it is essential to getting a complete picture of the borrower.
  3. Make your offer based on the borrower’s credit risk profile – First, build a credit risk profile on the borrower and use the predictive score to make your loan offer. It is best when lenders are able to structure a loan based on a consumer’s risk level. For example, a higher risk customer might warrant a smaller loan amount to control the lender’s risk.

Assessing Credit Risk: The Perfect Solution for Online Installment Loan Providers

The most important factors in underwriting the subprime consumer involve credit risk assessment and fraud detection. New solutions that combine the largest visibility into the industry’s alternative credit data and traditional bureau data ensure lenders are fully equipped to assess and mitigate risks. These solutions are offered by Experian’s Clarity Services and Experian, and include:

  • Clear Credit Risk
  • Clear Advanced Attributes

These solutions are designed to assess a borrower’s creditworthiness or to determine credit eligibility. Lenders receive an actionable score with adverse action codes to help them determine whether a potential borrower is a solid credit risk and to help determine a reasonable loan structure.

Clear Credit Risk is Clarity’s trademarked credit risk product designed to predict the likelihood of a borrower’s default on the first payment. It includes an effective score and is built on data that has proven most predictive for subprime consumers.

Experian’s Clarity Services is a credit reporting agency founded in 2008 and acquired by Experian in 2017. As the leading alternative credit data provider, the company services a wide variety of alternative finance lenders such as auto finance companies, check cashing services, prepaid credit card issuers, short-term installment lenders, small-dollar credit lenders, telecommunications providers, and more.

Authors:

Allen Taylor

Connecting Small Dollar Lenders With Borrowers Through a Mobile App

Hundy small dollar lending

After the Great Recession from 2007-2009, income growth nearly flattened for the average American while prices have been continuously rising. Almost half of America is unable to raise $400 for an emergency. With payday loans turning out to be predatory debt traps, it is almost impossible to raise a small loan for a short period […]

Hundy small dollar lending

After the Great Recession from 2007-2009, income growth nearly flattened for the average American while prices have been continuously rising. Almost half of America is unable to raise $400 for an emergency. With payday loans turning out to be predatory debt traps, it is almost impossible to raise a small loan for a short period of time.

Realizing the fact that almost two thirds of the country is under a non-prime credit risk, Hundy wanted to reduce the grievances of the new middle class. The idea was to build a true peer-to-peer lending marketplace which would serve as a platform for raising loans of up to a few hundred dollars at a low interest rate. The platform is open to everyone and is easy to access. It is a friendly, convenient, and transparent way to borrow money from peers.

The mobile application is a community-based model which facilitates interaction between the borrower and lender. The company’s long term goal is to build a network where people can borrow, save and invest, all at the same place.

Focused on small dollar loans in the marketplace lending market, Hundy is based out of San Francisco. The mobile native platform was launched in 2016 and focuses on providing loans to the underserved at a fair price. It has raised over $400,000 in a friends and family round. In a conversation, Pete Budlong, the founder and CEO of the company, discussed how instability has become the new normal after 10 years of recession and how Hundy addresses this issue.

How Hundy Works

Getting a loan over the Hundy application is a very simple process. Users sign up using Facebook. After signing up, they sign agreements and link bank accounts. After a credit approval process, their profile is ready and they can start applying for loans. The company offers the option of hard and soft credit pulls so as not to adversely affect the user’s credit score.

On getting credit approval, users can immediately request their first loan of up to $100. However, if not approved automatically, they’ll get approved based upon their participation in the community over time. Once approved and a request for a loan has been made, the user’s application is processed within minutes and the loan amount transferred into their bank account by the next business day.

Loan payments, along with a repayment fee, will be withdrawn from the user’s bank account on the selected date of repayment, which can be up to four weeks after the date of loan issuance. If the user can’t pay off the loan on time, there is an option to convert the loan into a 60-day installment loan with no penalty. Every time a loan is paid off, the borrower’s credit limit will go up until it reaches the maximum of $250. The borrower is updated throughout the process via e-mails and text messages, making all transactions over the platform transparent and fair.

The company has originated over 1,000 loans and has an APR of 180% as compared to 350% for traditional payday lenders. Its main competitor in the online space is LendUp, and it competes with payday lenders in the offline market.

Hundy’s Reach and Market Stats

Currently holding a full lending license in California, Hundy is planning to expand its services to other states in the US. The app will be launched in Texas and Florida by the end of this year. The mobile application was ranked as high as 89 in the app store under the finance category with about 70K registered installs. Around 60,000 downloads are wait-listed. This is a massive reach considering that the company is not engaged in any kind of advertising activity. Another co-founder of the company, Ram Hegde has been operating a developer team in India, and a team of two in the US is helping Pete with the marketing.

The community currently has a monthly growth rate of 30%, which is doubling every two to three months. Most of its traffic, about 95%, comes from iOS devices.

Hundy’s Future Plans

The company’s goals are structured into three milestones. The first leg constitutes the launch of the social feed, which is already finished. Almost one-third of Hundy’s borrowers participate on this social feed. The second leg accounts for a non-profit lending product. The company made a formal announcement for the non-profit product at the Money 20/20 startup academy. The third leg involves for-profit crowdfunding, and the company aims to accomplish this by the end of this year.

As of now, the company is not looking to raise money but to originate borrowers. Once the application manages to strengthen its hold on the borrower side, it will focus on engaging lenders. The aim is to build a community-based lending platform where borrowers and lenders can directly interact with each other. These communications between various stakeholders also help create a database for developing machine learning- and artificial intelligence-driven algorithms for the platform. Currently, the company is serving accredited investors through a Reg D exemption but will soon leverage Reg CF and Reg A+ for allowing unaccredited investors to pool their money for loaning to potential borrowers.

Conclusion

People find it difficult to take out small loans at a reasonable rate of interest. The Hundy application proves to be a great platform in such scenarios, offering short-term loans at a fair price. It is aiming to provide affordable loans, not just in California but all across the US, by building a community where borrowers and lenders can communicate directly with each other through the app.

Author:

Written by Heena Dhir.

Small Dollar Lenders Are More Beneficial Than You Realize

Small Dollar Lenders Are More Beneficial Than You Realize

Sam has a side business repairing fences and one of his bids was just approved to begin work immediately. Now he needs to come up with the money to buy supplies a few weeks before he receives payment from the customer. Because of unpaid medical bills from several years ago, he has a low credit […]

Small Dollar Lenders Are More Beneficial Than You Realize

Sam has a side business repairing fences and one of his bids was just approved to begin work immediately. Now he needs to come up with the money to buy supplies a few weeks before he receives payment from the customer. Because of unpaid medical bills from several years ago, he has a low credit rating, and applications for small business loans have been denied.

Joan is an artist with a promising jewelry line. She’s invited to sell her products at a popular bridal show that will result in big sales and future business opportunities at local boutiques. However, Joan must come up with money upfront to pay for booth space, displays, and material to make the jewelry. Since Joan has high credit card debt, she can’t access traditional financing.

The FDIC says nearly a quarter of U.S. households used alternative financial services in the past 12 months. One major factor is that two out of five Americans experience income swings of more than 30 percent month to month. In fact, 15 percent of U.S. consumers — approximately 37 million adults— do not have a bank account, according to a 2016 Pew Charitable Trust Study.

These statistics underscore the need for alternative financial services to assist unbanked, underbanked, and sub-prime consumers who have credit scores under 600.

It’s clear that consumers need to be fully educated on responsible borrowing, managing finances, and budgeting. There’s a reason why the CFPB established new regulations on certain lenders, including payday loans, auto title loans, deposit advance products, and longer term loans with balloon payments.

In general, regulations seek to provide consumer protection and ensure that lenders are acting in an ethical and professional manner. The concern is regulation that impacts and limits consumers’ access to credit. In an ideal market, regulated lenders provide financial services that meet a market need. As lenders compete for business (providing credit), it becomes the consumer’s responsibility to review the options and make the best choices for themselves.

An open market will foster competition and ensure that the appropriate lenders survive. Competition fosters innovation and drives new choices for consumers without the need for externally imposed limits.

Consumers Need Access to Emergency Cash

A major consideration that can’t be overlooked is that certain customers with poor credit scores many times need access to emergency cash. If their credit scores are too low, they are not able to borrow from banks or may not be able to obtain help from friends and family.

By definition, a subprime consumer (550-620 FICO) is likely to default on a loan 50 percent of the time. That’s a costly business decision for any lender.

If the market steps in and imposes more regulations on alternative financial service providers, the likely result is that loan requirements will become more conservative. Banks and traditional financing options will remain unavailable for borrowers with the lowest credit scores, and the increased cost of doing business could push some small-dollar alternative lenders out of the market.

Now, before you jump for joy and say that this is exactly what needs to happen, consider the potential consequences.

With many Americans living paycheck to paycheck, getting laid off, medical bills, an unexpected car repair, or emergency trip to a sick relative may require quick cash. Where will the consumers with low credit ratings turn in difficult circumstances and emergency situations?

One possibility, in the absence of small-dollar lenders, is that borrowers will get loans from less desirable lenders that operate under the radar, off the grid. Consumers who are desperate to pay bills, rent and car repairs, or buy medicine and other necessities of life may turn to loan sharks and other nefarious entities.

Does this seem like an unlikely scenario? Probably not.

Another possibility is that these consumers who tried to take care of themselves by borrowing emergency cash simply give up. With fewer options to fix their temporary liquidity problems, the need for government assistance will rise. If these consumers can’t pay for car repairs, can’t get to work, and lose their jobs, the result may be increased unemployment claims. Even more troublesome, the snowball effect could increase welfare programs and housing subsidies.

The reality is that underbanked consumers and borrowers with imperfect credit need alternative financial services. There are responsible alternative financial services and lenders who can provide small-scale, short-term funding.

If underbanked consumers and borrowers with poor credit ratings aren’t permitted to access credit, social welfare programs will be required to offset the consumers’ inability to meet short-term cash needs. This catastrophic situation will increase the cost and number of citizens on social assistance. Ultimately, all taxpayers will be burdened with increases in social welfare.

The question is rather than over-regulating this sector of the credit market, doesn’t a free market on certain alternative financing options seem to be a better alternative?

Author:

Guy Dilger is vice president of marketing at Plain Green, LLC. With more than 12 years of experience designing groundbreaking marketing strategies for Fortune 500 companies and financial technology brands, Dilger is known for generating engaging content and compelling concepts that resonate with targeted consumers. Prior to Plain Green, Dilger held senior positions within fintech and retail spaces where he managed national marketing campaigns and customer-centric loyalty initiatives for Sears and Kmart. Previously, he was part of the management team at Limited Brands where his marketing work in support of Express brand included CRM, email, web-based programs and the redesign and relaunch of a private label credit card. Dilger has an MBA, as well as a bachelor of science in economics, from Southern Methodist University.