Part I: Alternative Data Drives Auto Lending Growth

The American dream is to own a home, but what about a car? While public transportation is generally easy to use in large cities across the U.S., a majority of people have the desire to drive their own cars. Given widespread access to credit, consumers are projected to buy almost 17 million cars by yearend 2017. Last year, more than 75% of new car buyers used some form of financing to obtain a vehicle. Nonetheless, there are also populations of consumers without credit histories that seek easier availability to loans for vehicles and are having trouble financing their cars.

How can auto lenders increase their consumer portfolios, widening the populations to whom they lend, without facing a significant amount of increased risk? The solution is for auto lenders to open up the doors to non-traditional borrowers and become less restrictive in their lending, but doing so in a calculated and methodical manner.

Historically, auto lenders have utilized a modified version of the standard credit score by looking at a borrower’s debt-to-income ratio, the amount borrowed and the down payment, the age of the vehicle, and the length of the loan. This “traditional data” includes information about a borrower’s payment history, credit utilization, credit age, types of credit (such as revolving or installment) and the number of inquiries on the applicable borrower’s credit file. This type of traditional data is fairly transparent and provides a lender with a surface-level view of a borrower but does not offer an in-depth look at how a borrower is likely to act when faced with a complex array of debt.

Today, auto lenders also evaluate a borrower’s history with respect to previous auto loans. This means that auto lenders still use the basic framework from a credit score that is seen on credit card statements or on annual credit checks, but place more importance on how a borrower has repaid prior auto loans.

For auto lenders to have a better understanding of potential customers, they can review applicants by utilizing alternative data. This information includes details that are typically not part of a traditional credit report such as phone bills, checking and debit account management, property, tax and deed records, as well as whether a borrower has payday loans. Payday loans, which are short-term loans that usually have high interest rates, can indicate that a borrower is living paycheck to paycheck. To be clear, cell phone bills and utility bills are included in traditional credit scores about 3% of the time. However, with over 90% of American adults having a cell phone and approximately 60% paying for utilities, this information should be included whenever possible to provide a better assessment of borrower risk.

For the estimated 80 million Americans who rent their residence, only .3% of their credit scores reflect their rental status. Alternative data acts as a supplement to traditional data and provides a more comprehensive view of how likely a borrower is to repay a loan. By using alternative data, a lender is able to review a diagnostic report of a borrower’s performance prior to any formal extension of credit. Alternative data is already being used in other lending industries including by those institutions extending credit and mortgage loans.

Opening Doors

If auto lenders utilize alternative data, they will have the ability to increase lending to consumers with little credit history. These so-called “thin-file” potential borrowers do not necessarily represent a higher repayment risk to lenders — they just lack a history of documented borrowing. Some of the thin-file groups that stand to benefit the most from the growing acceptance of alternative data include millennials, minorities, immigrants, rural dwellers, and those returning from an absence to the economy.

Like most communities, transportation is vital to economic survival for these groups. Members of these groups, especially millennials and immigrants, often live in a “cash economy,” meaning they are paid in cash and make purchases with cash. By not establishing a track record of responsible debt management practices, they face a higher risk of being turned away by cautious lenders. People who have been absent from the economy for an extended period of time, such as soldiers returning from long deployments, newly-released prisoners, and volunteers for international humanitarian organizations, can encounter similar difficulties when applying for auto loans.

Consumers from these groups, who often do not use traditional financial services or whose needs are not met by traditional financial services, often choose not to use traditional lending platforms and thus are deemed “unscorable” when evaluated solely with traditional data. Knowing that a borrower timely pays his or her cell phone bill, rent and subscription services is valuable information that may help a lender feel more comfortable extending credit. Without alternative data, this information is not considered and lenders miss the opportunity to learn more about their borrowers.

In a 2015 TransUnion survey conducted by Versta Research entitled “The State of Alternative Data,” 87% of lenders reported that they are have not extended credit to some credit applicants because of their thin-file status. That is why alternative data may be key to unlocking more industry growth. In many cases, when lenders have extra information about potential borrowers, they feel more comfortable approving loans.

Debbie Hoffman is a managing member of Symmetry Blockchain Advisors where she works with clients through her expertise in law, finance, blockchain, cryptocurrency, and technology innovation.