Consumers who turn to alternative loan products are commonly perceived as underbanked or too risky to access traditional credit products. In a recent study conducted by TransUnion, the findings suggest there is a creditworthy segment of alternative loan borrowers that also perform well with traditional credit products like a credit card or personal loan.
Alternative loans, which include short-term loans, short-term installment loans, virtual rent-to-own or point-of-sale finance, are a category of credit obligations not visible on traditional credit reports. In TransUnion’s alternative credit database, which includes consumers who have applied for or received one of these loans in the past seven years, 66 percent of the population was considered subprime, compared to the risk distribution of the overall credit active population which typically stands at 25 percent. For our purposes, subprime is typically defined as consumers that have a VantageScore 3.0 score that falls below 600.
While the study did find that consumers who have utilized alternative loans are inherently more risky, conventional wisdom has suggested that these consumers participate in this market because they cannot access traditional credit products. However, TransUnion took a closer look and found not only 12 percent of these consumers have prime and above VantageScore scores over 661, but many across all risk tiers have recently opened traditional credit products.
TransUnion studied the loan performance of over five million consumers who originated a traditional credit product between Q2 2015 and Q1 2016 and measured the performance for 12 months following the origination of the loan. Approximately 450,000 (or 8 percent) were also present in TransUnion’s alternative credit database. This overlap suggests that consumers who are active in the alternative loan markets are qualifying for and opening traditional credit.
TransUnion then compared the performance of consumers present in the alternative credit database to consumers who did not participate in this market. While it continued to hold true that many alternative credit consumers had higher delinquency rates on traditional loans, the study also identified some material pockets of consumers whose good performance in the alternative credit markets may be an indicator of lower delinquency levels on traditional credit. For example, consumers who used alternative loans multiple times as a regular part of their financial management strategy actually had lower delinquency rates on traditional credit products than those who accessed alternative credit only once. The study concluded that consumers who utilize short-term loan products as a regular credit vehicle for managing their finances appear to manage all debt more responsibly than other borrowers in the database with the same traditional credit profiles.
These findings present an interesting opportunity for financial institutions that do not have insight as to which segments of their customer base are using, or have used, alternative credit products. By looking at the credit risk more comprehensively and taking alternative loan data into consideration, lenders may be able to more accurately differentiate higher risk consumers from lower risk consumers and have a better ability to identify and quantify risks.
Lenders can use additional attributes available in the alternative lending database, such as number of zip codes, velocity of inquiries, the number of short-term loans, and various other characteristics, to further assess risk. For example, consumers who had numerous address changes on file or were associated with a high number of cell phone numbers were also more likely to be delinquent on traditional credit products. Taking note of these potential “high-risk” indicators and incorporating additional data points can help separate that risk. This provides an opportunity to go above and beyond just knowing if a specific consumer is present in the alternative lending database and provides a more comprehensive understanding of consumer behavior.
Currently, the majority of lenders are not getting the full picture on this consumer segment as alternative loans are one of the largest credit categories not reflected in the traditional credit file. Arming lenders with more data to evaluate consumers can provide them with greater confidence to extend credit where they may not have previously. As a result, borrowers would also benefit as they may gain greater access to traditional credit products and build their credit files. Taking a deeper dive into the data and behaviors surrounding consumers with alternative loans may not only result in a larger financial inclusion story, but may also be a ‘win-win’ opportunity for the whole market.