The New Focus on Fintech Lending
Fintech is moving to capture a segment of the market that desperately needs their help – individuals with subprime credit scores. The goal is to transform the negative connotations of short-term loans into a model of lending to improve credit and financial decision-making.
It’s an Alternative Lenders Market
As many as 23 million Americans borrow annually from alternative lenders. This is often to cover things like car repairs, paying their bills, or emergency expenses. These short-term loans are a lifeline for many that live paycheck to paycheck, with some individuals having a higher than expected income but a poor credit history that limits their options to borrow.
Similarly in Canada, as many as a third of Canadians have low credit scores. This subprime market consists of would-be borrowers with a FICO score less than 670. Individuals with subprime credit scores have limited options when it comes to borrowing money. For many subprime borrowers, good borrowing options simply don’t exist when things go wrong financially. And they will need to borrow since roughly a third of Canadians don’t have enough cash on hand to cover a small emergency.
Transforming the Industry
Those with subprime credit scores have long been underserved in the financial market, but start-ups and small companies within the US and Canadian Fintech market are looking at the possibilities and capturing a significant market share. There are many companies offering innovative financial solutions to these borrowers and finding success. This is spurring more investment in the industry as services continue to grow.
Already borrowers in this credit range have more options than they did before. There are apps available that help account owners get cash two days faster. There are prepaid credit cards that create accounts online that include bill pay features. Subprime borrowers can get loan approval almost immediately through cash-based underwriters which makes borrowing less expensive for users, but still profitable for investors.
Cash Flow underwriting is different from the traditional lending model banks use. The cashflow method focuses less on credit scores and instead focuses on the expenses surrounding a borrower’s paycheck. It monitors how much money is going out before and after payday. It also monitors how much cash is coming into the account – the borrower’s cash flow.
Often this information is more useful as a basis for borrowing than a FICO score which can be impacted for years after a single financial mistake. Pair cash flow underwriting with the tremendous advantage of AI algorithms and machine learning and you have a full disruption in the financial markets for these borrowers.
Caution and Education
The start-ups and innovators in the subprime market know that there is additional risk. After all, subprime credit scores didn’t happen by themselves. They are the result of poor financial choices on the part of the consumer. Financial companies are mitigating this risk by focusing on cash flow and also by educating the consumer.
Since most banks are not willing to serve consumers with poor credit history due to the potential risk, they have literally created the opportunity and the market some years ago. With default rates exponentially higher in many cases, the risk isn’t for most lenders. But with the use of machine learning, artificial intelligence and alternative data, a credit score is no longer the only source to reference for evaluating loan requests or risk, and can even reduce the likelihood of default.
The new world of poor credit lending isn’t predatory. It’s designed to be a meeting between what consumers need, small loans on a short-term basis, and companies profits. By helping borrowers understand the market and how the lending practices work, financial companies are empowering borrowers and helping them work back toward financial success with better terms.