Modern Lending: The Use of Alternative Data in Credit Underwriting

Modern Lending: The Use of Alternative Data in Credit Underwriting

Traditional credit data has been a key indicator of a borrower's creditworthiness. And though this remains unchanged, we're evolving to incorporate alternative data into it.

Alternative credit data are allowing lenders to have a fuller understanding of borrowers' financial situations. Lenders can expand their customer base and provide more customers with access to credit by collecting and analyzing additional data.

Let's take a look at how modern lending is evolving. Read on.

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Alternative Credit Data

For every loan application, there's a credit underwriting process, which systematically evaluates the applicant's risk. Assessing a potential borrower's or applicant's creditworthiness is an essential part of any financial institution's (FI) lending operations.

The term "alternative credit data" or the “Non-traditional credit data” refers to information that isn't included in regular credit reports but can still be used to assess creditworthiness and is controlled by the Fair Credit Reporting Act (FCRA)

Alternate data sources have been making waves in the financial industry throughout the past few years. Fintech companies and other financial institutions are only scratching the surface of the unrealized promise of alternative data. When the appropriate alternative data and metrics are utilized, predictive models can experience considerable improvement.

However, as the use of alternative credit data becomes the norm in underwriting, lenders are increasingly relying on new kinds and sources of data. Modern-day loan providers frequently employ the following:

  • Consumer permission data

You can access transactional and account-level data from a consumer's bank accounts with the consumer's permission to better estimate the consumer's income, assets, and cash flow. Access to this information can also provide insight into the payment history of non-traditional accounts, such as those for streaming services, cell phones, and utilities.

History of rent payments Property managers, electronic rent payment systems, and rent collection firms can share information on the rent payment history and lease terms of consumers with one another.

  • Alternative financial services (AFS) data

Credit data from alternative financial services (AFS) might include information on customers' utilization of rent-to-own agreements, small-dollar installment loans, single-payment loans, point-of-sale financing, and auto title loans, among other types of loans and financing.

  • Public Records

Documents available to the public, including The consumer's professional and occupational licenses, education, property deeds, and address history, can all be found in local and state-level public records.

  • Buy Now Pay Later (BNPL) Data

You can view your payment and return histories, in addition to upcoming scheduled payments, using the tradeline and account data provided by BNPL. As more and more customers opt for this novel kind of in-store financing, it stands to grow in significance.

Benefits of Using Alternative Data In Credit Underwriting

Here are some benefits the financial industry can experience by incorporating alternative data in underwriting.

  • Improves Businesses

A more complete and nuanced picture of the behavior of customer behavior can be obtained from alternative databases. It inevitably enables financial institutions to make more informed decisions. They can target customers better and build more substantial products to expand their portfolio.

However, an improved method of gauging a customer's creditworthiness guarantees not only profitable but also low-risk credit and loan transactions.

  • Promotes Economic and Social Participation

Fintech companies and non-bank financial companies (NBFCs) can reach the unbanked and underbanked people by using alternative sources of data and metrics.

Alternative data sources are less prone to manipulation, and they can serve as a source for scoring applicants who are underbanked, credit invisible, or who are commonly referred to as having a "no-hit" or "thin-file" by traditional models.

The insights that can be gained from alternative data can improve loan availability for consumer groups like these that are typically ignored. For instance, those who have never applied for a credit card or a loan before do not have a credit history or a background that satisfies certain criteria.

Financial institutions can better profile such candidates and meet their credit standards thanks to alternative data points.

  • Identifying Potential Fraud

Platforms in the digital realm that automate the provision of data are of critical importance to the collection and dissemination of alternative information.

Unusual occurrences in corporate processes or financial dealings of an individual can be uncovered with the aid of artificial intelligence (AI), machine learning (ML), deep data analytics, and anonymous information.

Artificial intelligence (AI)-enabled solutions leveraging alternative data, for instance, allow lenders to identify potential financial fraud perpetrators during the pre-qualification process.

Final Take

Lenders have been exploring and employing alternative credit data for quite some time. However, as they attempt to adapt to shifting customer expectations and economic instability, the data's usage in underwriting may become increasingly crucial.

Soon enough, traditional financial institutions will begin using alternative data sets as part of their routine lending procedures. Identifying the best mix of data sources and how they affect profitability is essential for realizing the value of alternative data.