The small-dollar credit (SDC) market — think payday and auto-title lending — is ripe for innovation and disruption. Most of the $44 billion industry consists of high-cost, low-quality products that lead people into cycles of repeat usage and mounting debt. Regulatory burdens, reputational risk and the tough economics of making small loans profitable have limited the supply of high-quality options available in the marketplace today.
However, technology-enabled approaches and shifts in the costs of data are creating new opportunities for innovators to serve the millions of Americans seeking access to high-quality, affordable credit. Upcoming regulatory changes from the Consumer Financial Protection Bureau (CFPB) are expected to shake up the industry by making it harder to offer bad products and clarifying the rules of the road for offering high-quality, small-dollar loans.
Tech-savvy lenders are uniquely positioned to fill this void by leveraging technology and data to reduce the costs of lending, while improving the borrowing experience for Americans using these products. A series of new reports from the Center for Financial Services Innovation (CFSI) highlight strategies for offering high-quality loans in an affordable and profitable way.
Here are three ways that lenders can leverage technology to offer credit to the large and growing subset of borrowers in need of high-quality solutions.
Go Big On Data
The availability of extensive data is revolutionizing the underwriting process. For too long, lenders have relied on imprecise metrics, such as FICO scores, to guide their lending decisions. However, an exciting crop of innovators is leveraging “big data” to refine their underwriting techniques and risk assessments. CFSI has found that a growing number of innovative lenders are using proprietary algorithms, fueled by sophisticated data sets, to extend credit to borrowers who would not traditionally qualify for these products.
For example, LexisNexis Risk Solutions’ RiskView Score draws upon alternative data such as property data, public records and address stability. Early results from a pilot with Los Angeles-based Kinecta Federal Credit Union suggest that this new kind of score is allowing Kinecta to more accurately assess borrowers’ risk profiles.
To better match borrowers with a loan that fits within their budget, innovative lenders are offering borrowers the opportunity to customize their loan amount and terms, within ranges that underwriting suggests they can afford. Enova International, one of the largest online consumer lenders in the country, launched an online “payment slider” tool on their NetCredit Gold product. The tool allows borrowers to select the size of their payments and the length of their loan term.
Through a randomized control trial, Enova found that prospective borrowers who saw the tool and proceeded to the second page of the online application process had higher conversion rates than those who did not receive the payment slider tool. Customers who received the payment slider tool and used it to change a payment also had lower default rates than those who did not receive the tool or than those who received the tool but did not use it to change a payment.
This experiment suggests that allowing borrowers to customize their borrowing experience is a win-win for lenders and customers alike.
Cut Costs, Not Access
Because the profit margins of small-dollar loans are relatively low, lenders must find ways to responsibly reduce the costs associated with offering these loans. Adopting technology solutions will allow lenders to reduce processing costs and provide borrowers with cheaper access to credit. Lending Club and Prosper, two of the leading marketplace lenders, offer customers loans exclusively online for interest rates that are generally lower than industry averages. To get a loan, applicants must submit their information online and explain why they need money. The lenders then check applicants’ credit reports and assign a grade and fixed interest rate.
Both companies make decisions within days, and borrowers can seamlessly receive their funds online. By fully automating the lending process, Lending Club and Prosper can provide access to cash at prices that are often cheaper than carrying a credit card balance.
This is an exciting time for the financial services industry. A wave of technology-forward innovators stands ready to disrupt an industry sorely in need of change. The CFPB’s upcoming regulation of the industry will offer innovators unprecedented opportunities for capturing business from borrowers who may have previously resorted to costly payday loans.
Source: TechCrunch, Sohrab Kohli, Thea Garon
Sohrab Kohli is a researcher for the Center for Financial Services Innovation and Thea Garon is a researcher for the Center for Financial Services Innovation.