Access to Fair Credit: Building a new underwriting Model
Andreessen Horwitz, a VC Firm, published a seminal framework for developing new financial products by leveraging payroll data. You can read the article here. The Promise of Payroll APIs
This is in-line with our thinking of developing new and more inclusive financial solutions with new data sets that are available, but not used by lending companies and banks for millions of American workers who are either ‘underbanked’ or have limited or no credit history.
In my previous post, I talked about why financial inclusion is the key for developing a prosperous and just society for everyone. And how platforms like Orbispay can help develop financial solutions such as Access to Earned wages and Access to fair Credit for millions of Americans.
The story of Bella is important and worth repeating for understanding the financial challenges faced by most working Americans.
I know Bella. She works at the grocery store near me. She has limited access to credit. When she needed to borrow $200 for a car repair. The only way she could get the money she needed was through payday loan company. They were happy to ‘help’ her. In exchange for a $200 loan, they would charge her $20 interest plus a $20 processing fee for a 15-day loan. She was already out of $40 for the $200 she needed to borrow. This amounts to an APR (Annual percentage rate) of 485% for a 15-day loan! She had no choice, used the payday loan, and was stuck with the interest rate she or anyone in her situation could not afford.
This is not a crime in America. Payday lenders can legally charge this rate.
So, when she needs credit, she ends up borrowing at a very high interest which puts her squarely in the middle of a vicious and hard-to-break - debt payment cycle.
Is this fair? What is the difference between Bella and me? I can get an inexpensive loan anytime I want or need it, but she cannot.
The current underwriting model relies on FICO score and does not reflect whether Bella can afford a loan.
Banks used the “Willingness to pay” Model. This model relies 100% on FICO score. The higher the score, the better the credit you can get. The FICO score is an indicator for people with ‘good credit’. It makes lender’s job easier … they just run the score, and make an offer based on that score.
However, the FICO score is:
A. A lagging indicator and
B. Does not help people who are ‘underbanked ‘or have little or no credit history but may have the ability to pay and are ignored.
The New Underwriting Model:
We believe Access to credit is a right, and not a privilege. We are developing a new underwriting model that will address some of the shortcomings of the current model. The model is based on Bella’s “Ability to pay”. The new model will reflect whether Bella can afford and re-pay the loan.
This is how the new model works:
1. We use Payroll data for both underwriting and servicing loans. With payroll data, we can verify income and employment information much more quickly.
2. The loan re-payments, for example, are structured as equal amount spread over 12 to 36 months. The loan payment is paid through the deductions from the paychecks which de-risks the loan, reduces defaults and improves credit.
3. We also use financial data including FICO score in the underwriting of a loan. The FICO score, however, weighs less than 25% in our calculation.
Now with payroll and banking data in hand, we can build a better financial picture of Bella and can offer a fair and competitive rate tailored to her income stream.
However, there are number of challenges in developing new financial models, namely data aggregations, governance, and privacy issues. Similarly, the compliance and regulations landscape are complicated and difficult to navigate. Each state has its own lending and payroll handling requirements. A standardized policy at a federal and states level is needed for developing inexpensive financial solutions.
Most fintech startups including our team have technical and financial services know how, what we lack is a uniformed compliance, regulatory policies and framework which we can adopt.
Our goal is to build financial solutions which are affordable and can provide immediate and long-term benefits to working Americans. I believe, providing access to fair credit to Bella and millions of American is the starting point for fulfilling the American dream.
Feel free to reach out to me with any suggestions for improving our model and services.