For subprime lenders, three macroeconomic trends are affecting credit considerations on an applicant-by-applicant basis. Lenders caught flatfooted in response to these trends risk diminishing their ROI.
- Despite impressive job and market growth, 56 percent of consumers had subprime credit scores in 2015, according to the Corporation for Enterprise Development (CFED).
- Cash is no longer king. The average consumer uses their debit card at least 21 times per month, a 32 percent increase throughout the past decade, according to a 2015 debit issuer study commissioned by PULSE.
- More lenders are beginning to understand the unreliability of the traditional credit score. Each year, 68 to 82 percent of borrowers are new to the subprime market, according to non-traditional credit reporting bureau Clarity Services. An even higher percentage of borrowers will be new to any given vendor. Almost 10 percent of these are thin- or no-file millennials with very different financial backgrounds than previous generations.
Here’s the good news: With access to targeted data, lenders can find reliable opportunities for growth while minimizing potential risks.
Subprime Credit Consumers: the New Majority
Subprime lenders are used to lower credit scores. Since new circumstances have put more consumers in the recent subprime majority, however, it’s worth exploring the circumstances of this larger share.
The financial crisis of 2008/09 occurred during the same time that millions of millennials came of age. In 2015, CreditCards.com found that a third of those aged 18 to 29 did not have credit cards. In 2009, the CARD Act limited the ability of companies to market credit cards on college campuses, cutting card issuance almost in half. As a result, the credit histories of millions of young adults are even more abbreviated than usual, contributing to the new subprime majority.
Additionally, a 2015 Consumer Financial Protection Bureau (CFPB) report explores the 26 million Americans who are “credit invisible,” and the 19 million considered “unscored” by the traditional credit bureaus. While one in 10 Americans don’t have any credit history, an additional 8 percent have insufficient histories, leaving them under-serviced in the credit industry.
These are the economic currents that have more subprime lenders seeking non-traditional sources for data.
Once upon a time, cash was how we paid for most things. Times have changed.
Today, cash accounts for about 14 percent of transactions, according to The Federal Reserve System Cash Product Office. The average American spends roughly $100 a day, according to Gallop, but walks around with only $20 cash, according to Bankrate.com.
A majority of younger adults in the developed world would have no problem with a completely cashless society, says data from ING Group/eZonomics. Given the difficulty of accurately determining a credit score for so many in today’s economy, now is a great time to consider additional measures for understanding an applicant’s financial stability.
Why More Data Is Needed for Scores
Before the Great Recession, lenders relied almost exclusively on traditional credit scores. The Big Three credit reporting agencies employ traditional models composed of criteria like bank loans, car loans, credit card bills, student loans, mortgages and various credit data. Unfortunately, for many millions of those in need of credit services, the above criteria simply won’t work.
But with the subprime majority of today, a number of creditors are looking at other factors.
- Ability to pay: Regardless of income level or percentage of residual income, research shows that as long as an applicant for a subprime loan is earning money and has some residual income, they’re probably a safe bet. Of course, that’s assuming there aren’t any red flags for intent not to pay, such as an inability to prove bank account ownership.
- Alternative data: Non-traditional credit data and alternative data are not the same. Non-traditional credit data is targeted squarely on credit behavior, whereas the latter often uses more peripheral sources. That can include data from social media to verify a job or location, histories from utility bills and Census data.
Connecting the Dots with Targeted Data
What is meant by “targeted data?” As the largest subprime credit bureau, Clarity Services leverages one of the largest targets available – debit cards. Every five seconds, one new debit card is issued in the United States (PULSE).
In recent years, debit cards accounted for the leading share of payment types. Their usage grew to 69.5 billion in 2015 with a value of $2.56 trillion, up 13 billion or $0.46 trillion since 2012, according to a recent Federal Reserve study. Non-prepaid debit card payments, the type typically connected to checking accounts, grew to 12.4 billion with a value of $0.42 trillion from 2012 to 2015. This is after an increase of nearly 39 billion debit card payments from 2000 to 2012.
Half the time, Americans pay for groceries with debit cards, which are also used significantly at department stores, restaurants and other retailers, according to a TSYS 2014 consumer payments study.
What Debit Cards Say about Consumers
Why do so many prefer debit cards? The TSYS study shows that 66 percent of users like the ability to have purchases deducted directly from their checking account.
For subprime lenders looking to make better decisions in our cashless society, what could debit information reveal about an applicant’s financial circumstances? At a glance, debit and bank account info could yield immediate details to help confirm a high or low credit risk.
Confirmation of primary bank account ownership status
Total number of debit cards
Number of social security numbers associated with a debit card
Number of social security numbers associated with a bank account
Lenders may be able to see whether an applicant’s details are false, incorrect or somehow inconsistent by using the granular details offered by reason codes, which can answer the following yes-or-no questions:
- Is the account in good standing?
- Is the account associated with a high-risk bank?
- Is the CVV a match?
- Is the ZIP code incorrect?
- Did retail transactions take place in the last 24 hours?
An Old Problem in a New Space
The details above not only yield insight to help manage risk of default, they also speak to another growing problem for lenders in spaces including rent-to-own, online and storefront installment – fraud.
As creative as fraudsters have been for things like payday loans, they are now applying many of the same tactics in the unsuspecting rent-to-own market. Lying on loan applications, account hacking and data leaked from the dark web are just some ways fraudsters are infiltrating the market.
The combined at-a-glance information with the more granular reason codes allow lenders to easily cross-reference data and glean a reliable impression of an applicant.
Adjusting to the New Normal
The “new normal” is an oft-cited term since the last economic crash. As subprime consumers have acclimated to today’s economy, lenders have benefited by adjusting to the market’s needs.
But have lenders fully capitalized on the new aspects today’s normal? For many, the answer is no. It’s worth analyzing the lifecycle of the consumer’s journey to subprime underwriting, and how lenders may simplify the process for the convenience of all parties involved.
Tim Ranney is president and CEO of Clarity Services, Inc., a real-time credit bureau providing credit-related data on subprime consumers. Prior to founding Clarity in 2008, Ranney spent 20 years as a leader in internet security and risk management, serving as COO of an industry leader and senior executive for both Network Solutions and VeriSign.