Alternative lenders offer cheaper loans for more of your data
Be ready to reveal your alma mater, what you have in savings and friends' phone numbers
By Kelly Dilworth | Published: April 20, 2015
If you're looking for a lower rate loan than what's available through your credit card, you may be able to find one by teaming up with an alternative lender. A growing number of alternative lending startups are offering personal loans with rates as low as 4 percent.
To qualify for one of these lenders' ultra-low rates, though, you may have to share more information about yourself than what's available through your credit report. In many cases, alternative lenders with the most attractive interest rates are asking borrowers to divulge a range of intimate details, including savings and checking account balances, purchase history, college majors, standardized test scores, phone numbers of trusted confidantes and more.
Better than FICO?
"This is how underwriting used to be 100 years ago," says Louis Beryl, CEO and co-founder of the lending startup, Earnest. Before the invention of consumer credit scores, lenders collected a wide range of personal details about their customers, such as where they lived, who they married, whether they had been recently arrested or promoted. "They got to know people very deeply," says Beryl.
Startups such as Earnest are trying to revive that tradition, in part, by asking borrowers for access to their personal lives in exchange for lower rate loans than what they'd be able to get through a traditional lender.
For example, Earnest looks at borrowers' education and job history, savings and bank account balances, monthly budget and spending habits, as well as traditional credit data, in order to get a close-up view of their financial situation.
According to Beryl, the lender's more thorough approach makes it easier to spot borrowers who are worthier of credit than their FICO score indicates. "You as an individual, you know about your cash flow, you know how much you're saving ... You have all this deep information about how you've lived your life." But traditional lenders aren't asking for that information, so you're not getting credit for it. "That's not fair," he says.
"When you apply for a credit card, and they don't ask how much savings you have in the bank, people should be like, 'Why? I have thousands of dollars in savings, I'm clearly a low-risk person," says Beryl. By relying solely on your income and FICO score to make a credit decision, a traditional lender could be offering you a higher rate than you deserve.
When you apply for a credit card, and they don't ask how much savings you have in the bank, people should be like, 'Why? I have thousands of dollars in savings, I'm clearly a low-risk person.'
|-- Louis Beryl
CEO, co-founder, Earnest
"We take a different approach. Give us the most information so we can actually understand you," he says. By taking into account a wider range of information, "we're able to make very fine-tuned underwriting decisions and reward financially responsible people with the best possible interest rates."
Consumer advocates skeptical
Not everyone's convinced, however, that using alternative data to make credit decisions is a win-win for consumers. "People should understand that companies are developing all sorts of new analytics and one of the edges that many Silicon Valley-backed big data lenders think they have is to use nontraditional data, which can be any kind of score generated from any kind of information," says Ed Mierzwinski, consumer program director for the advocacy group PIRG.
The problem is that alternative data that's generated in-house isn't regulated the way credit data is, says Mierzwinski, so the information that's used to make a decision can be kept secret from consumers. "If the company is using its own algorithm and it's not selling that algorithm and it's not selling the scores, then it may not trigger all the legal rights you have with a credit report."
The Fair Credit Reporting Act, for example, was created, in part, to rein in credit reporting companies who were digging into people's personal information and often supplying inaccurate information to creditors. To remedy that, the law requires consumer reporting agencies -- groups that collect consumer information and sell it to creditors, employers, insurance companies and other entities -- to provide access to the data it's collected and correct it if it's wrong.
If a lender uses alternative data that doesn't come from a consumer reporting agency, you can't ask to see the information that's been collected, nor can you dispute it if the data the lender is using is inaccurate. "It makes the marketplace less transparent," says Mierzwinski. "It means decisions are going to be made and we don't know why."
Even if you supply the data yourself by providing access to your checking account information or education records, the use of alternative data could lead to other problems, say consumer advocates, such as unintended racial bias or unfair decision-making.
"A lot of this data is untested," says Persis Yu, a staff attorney with the National Consumer Law Center. By relying on nontraditional data to make credit decisions, alternative lenders could also be making it harder for some consumers to improve their credit standing since they don't know what information is being used to judge them, she says. "If I miss a payment, I know that's going to adversely affect my credit and my ability to get a loan further down the road." But if a lender uses a multitude of variables from a borrower's personal and financial life, consumers could have a harder time anticipating the actions that will affect their ability to get a lower rate loan. "It's harder for consumers to go through the world and estimate or adapt their behavior."
A growing trend
Despite consumer advocates' concerns, the market for alternative lending has surged in recent years.
"We have an explosion in online companies right now," says Simon Cunningham, publisher of LendingMemo.com and an investor in online peer-to-peer loans. "There's an incredible momentum happening."
If the company is using its own algorithm and it's not selling that algorithm and it's not selling the scores, then it may not trigger all the legal rights you have with a credit report.
|-- Ed Mierzwinski
PIRG consumer program director
Since the Great Recession, a range of alternative lenders have popped up to help fill the void left by traditional lenders who have made it tougher for consumers with imperfect credit to qualify for an affordable loan.
"There are still tens of millions of Americans who are having a difficult time getting access to credit," says Yee Lee, co-founder and CEO of the alternative lender Vouch.
To help solve that problem, lending startups are trying to come up with fresh ways to evaluate borrowers underserved by traditional lending.
For example, Vouch offers rates as low as 5 percent to borrowers whose credit files are thin or nonexistent or have been tarnished by bad luck, such as job loss or illness. But to qualify for one of the lender's ultra-low rates, borrowers need to convince their friends or family members to join the Vouch network and "vouch" for them online by pledging to pay a certain amount if they lapse on their loan. The more high-quality vouches a borrower can get, the lower their interest rate will be.
According to Lee, the lender's unusual underwriting process -- which includes calling people up and asking for intel on a particular borrower -- has helped provide lower-cost loans to borrowers overlooked by the traditional lending system, including new grads and recent immigrants. "For all those folks, Vouch represents the way to get access to not only credit, but credit that's super affordable," he says.
A number of alternative lenders have also popped up in recent years promising to use alternative data to remake the payday loan system and offer less expensive loans to low-income borrowers. But they've come under fire from consumer advocates for offering interest rates that are nearly equal to traditional payday loans. For example, in 2014, the National Consumer Law Center profiled several alternative lenders that use big data analytics to size up potential borrowers and found that rates on some small-dollar loans ran as high as 748 percent.
A focus on millennials
The lending startups with the best interest rates have largely focused on young professionals who are just starting out, but have resumes and educational pedigrees that suggest high potential earnings. (See chart below.)
There is a whole group of people who fundamentally distrust credit and the financial system. They're not giving people the information they need in a transparent way to make an intelligent financial decision.
|-- Jeff Kadditz
Co-founder, chief strategy officer, Affirm
For example, the peer-to-peer lender Upstart -- which offers rates as low as 5.7 percent -- looks at recent graduates' educational transcripts, standardized test scores, college majors and even the prestige of their degree. So if a borrower went to a highly ranked university such as Stanford or Yale, he or she may have a better chance of earning a competitive rate.
"There are certain types of resumes that help you get a great job," explains co-founder Paul Gu, making it less likely you'll lapse on your loan because of extended unemployment. Because traditional lenders don't take those factors into account, borrowers with impressive resumes but limited credit histories often struggle to be taken seriously by traditional lenders, he says.
Many alternative lending startups are also luring high-potential borrowers by offering a more seamless online experience and innovative perks that can be hard to beat. For example, the alternative lender SoFi offers unemployment protection and career counseling when borrowers lose their job. Through resume help, job leads and even interview practice, "we've helped about 60 people find another job," says co-founder Dan Macklin. "These are the types of services that traditional banks have never offered and do not offer."
Many of the newest lending startups are also luring younger borrowers by capitalizing on their frustration with bigger banks and offering simpler loans with more transparent terms. For example, the startup lender Affirm offers a point-of-sale alternative to credit cards where borrowers can apply for an instant loan each time they make a big-ticket purchase and get transparent information upfront about exactly how much interest they'll have to pay over time.
"There is a whole group of people who fundamentally distrust credit and the financial system," in part because lenders aren't making it easy for borrowers to avoid getting buried in debt, says Jeff Kaditz, co-founder and chief strategy officer of Affirm. "They're not giving people the information they need in a transparent way to make an intelligent financial decision."
Kaditz believes the future of borrowing lies in offering people simpler, less expensive loans without traps or hidden fees. "As consumers get smarter in the information age, they're going to want the more transparent option."
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