In the 1950s, mathematicians and engineers created the FICO credit score with the belief that data analytics could help businesses and lenders make smarter decisions. Since then, the FICO score has been the go-to barometer to determine a borrower’s creditworthiness. But like so many other things that wane in popularity as they age, FICO’s reliability is increasingly called into question by modern lenders and fintech players that use machine learning algorithms and real-time enhanced data to gauge whether to give someone a loan. (Our post Could Great Yelp Reviews Soon Make Up for a Poor Credit Score? explores how enhanced data-points improve the accuracy of a borrower’s profile.)
Granted, traditional lenders still view FICO as the best risk assessment tool when determining whether or not to issue a small business loan. But at the Future of Fintech conference last June and in mediaconversations online, discussion on the declining usefulness of traditional credit scores indicates a shift may be imminent.
Alternative lenders already shy away from the FICO scoring model. Here’s why:
- Traditional credit scores only take into account a borrower’s prior credit history (Are they successful at making payments on a loan? Do they only use around 30 percent of their available credit?), which isn’t necessarily a reliable indicator of how he’ll act in the future.
- Borrowers can have valid reasons for being highly leveraged (a move deemed financially irresponsible by FICO). For instance, small business owners often put up personal assets as collateral for access to capital for their company.
- A lack of transparency about how the score is calculated doesn’t align with digital marketplaces’ business practices and is arguably not in the best interest or potential borrowers.
- FICO scores unfairly punish under- or un-banked individuals since they don’t always have the traditional data points used to develop the FICO score.
Perhaps the biggest reason some fintech lenders have sent the FICO score upstream is because they believe a wider range of data offer greater benefits, more real-time insights, and a more accurate indication of creditworthiness. Non-traditional lenders now regularly look at the following borrower data for SMB loans, sometimes as a supplement to the borrower’s FICO score:
- Monthly monetary obligations, such as utility, cable and rent payments
- Sales and shipping data, which can reveal the demand for the company’s products and service and its reliability at fulfilling customers’ orders
- Cash flow, since the amount of money going in and out of an online bank account reveals whether a borrower will be able to repay borrowed funds during the loan’s lifespan
- Social media accounts like Yelp, Twitter, and Angie’s List. Positive feedback and customer interactions indicate a thriving business; negative feedback, the opposite.
- Personal accounts, including email and mobile phone, can help a lender protect against potential fraud
Incorporating enhanced data points like these into the credit memo is a win-win for borrowers and lenders alike. This approach allows lenders to broaden their concept of who is considered a creditworthy borrower — increasing overall profitability and potentially reducing default rates. For borrowers, it means more small business borrowers have access to capital at more competitive prices.
For instance, if an entrepreneur wants to open his own business, but has never had a mortgage or car or school loan and made a few late credit card payments through the years, it’s likely that a traditional lender will deny him an SMB loan. By contrast, a loan application incorporating enhanced data-points will also take into consideration the fact that he’s dutifully paid his rent on time for more than five years, always paid his smartphone bill, and has amassed a large lump sum in his bank account, thanks to a recent raise. These added pieces of information give a more complete and up-to-date picture of a potential borrower’s overall financial situation, and if considered as part of his creditworthiness profile, he’ll likely qualify for a small business loan.
More data = more borrowers = more business for banks. Talk about an equation that demonstrates success for all parties involved.
Are you ready to expand your credit policy with enhanced data points? If so, let Mirador help.