The dark side of the FinTech loan
Consumers who turn to fintech lenders are more likely to spend beyond their means, take on more debt, and ultimately default more often than people with similar credit profiles who borrow from traditional banks, according to a recent study.
The study, Fintech borrowers: lax filtering or skimming?, was written by Marco Di Maggio, associate professor of business administration in the Ogunlesi family at Harvard Business School, and Vincent Yao, associate professor at J. Mack Robinson’s School of Business at Georgia State University.
The results go against conventional wisdom that fintech lenders collect more in-depth information about borrowers than banks typically reject after performing a standard credit check. Fintech lenders claim to look at additional metrics like utility bills or rent payments to identify creditworthy people who are overlooked by traditional lenders.
“If you place the results in the context that most FinTech companies claim to use alternative data, it’s very surprising that their borrowers are more likely to default,” says Di Maggio.
Di Maggio and Yao tracked 3.79 million loans for 1.88 million borrowers using detailed country data from one of the three major credit bureaus over several years. This allowed for an in-depth look at borrowers who turned to a financial technology company or bank for a personal loan. (A personal loan is an unsecured loan that is typically given to consolidate existing credit card debt at a higher cost.)
This is a much larger sample of consumer lending behavior than previous studies, which tend to focus on data from a single fintech lender like LendingClub and provide no banking comparisons. The authors then followed the performance of all borrower loans from four months before the personal loan was originated until 15 months after.
“Fintech borrowers only partially consolidate their debt, and then a few months later they know they have these empty credit cards and they start using them again.”
In summary, fintech borrowers who initially improved their credit scores by consolidating some of their credit card debt saw those scores deteriorate months later as they started using their lines of credit to consume more. of goods, from buying a car to buying everyday. articles, the researchers found.
A year after the fintech loan, more than 5% were likely to default. That’s a 25% increase in default risk compared to similar bank borrowers.
“Fintech borrowers only partially consolidate their debts, then a few months later they know they have these empty credit cards and they start using them again,” says Di Maggio. “And so the leverage starts to increase again, but now they have to pay off both the credit card debt. and the personal loan, which skyrockets their defaults.
This type of behavior is less likely among bank borrowers, suggesting that fintechs attract a different type of loan seekers – one with a higher propensity to overspend – which is not easy to capture in their credit reports. credit.
The rise of fintechs
The popularity of fintech loans exploded in the years following the financial crisis ten years ago. A growing number of them generated $ 3.79 billion in loans in 2017, eight times more than in 2013, the researchers note.
This surge, analyzed before the start of the pandemic, is expected to increase even more by the end of 2020, in part due to the premise that fintech companies can benefit from less regulatory control and appetite. investors for high returns.
But even with more defaults, fintech lenders weren’t likely to be hurt, in part because companies charge higher rates commensurate with higher risk. Borrowers with “thin” credit records, for example, were charged a premium 5% more than what banks charge for similar borrowers, the researchers found.
But there is also an advantage for fintech lenders. Their borrowers tend to be loyal, take on more loans over time, and are likely to get additional credit when they need it most, such as after a job loss, according to the research. This presents a dilemma for policymakers, says Di Maggio.
Fintechs bundle loans together and sell them to other investors, much like the home loans that helped propel the financial crisis.
A tool similar to the “repayment capacity” requirement introduced by the Dodd-Frank Act for fintech lenders could serve the industry well, suggests Di Maggio. The law “required banks to really ensure that borrowers will be able to repay their loans.”
“In the mortgage market, there are all these tests on debt-to-income ratios,” he says. “The fintech lenders who give you these types of unsecured debt don’t have to do anything like that.”
What consumers can do
On the consumer side, Di Maggio advises to watch spending carefully, otherwise things can quickly get out of hand.
“The biggest challenge is probably making sure that you are using the fintech personal loan for the right reason,” says Di Maggio. “This type of loan should be used as a consolidation tool or as a bridging loan to meet a specific and temporary need.
Loans should not be used to finance consumption. “Otherwise,” says Di Maggio, “it’s likely that you’ll end up spending too much money or overworking yourself, and then more likely to default, which will shut you out of the credit market altogether.”
Fintech firms, many of which only operated during an economic boom, are likely to suffer now during the historic pandemic-induced recession as some borrowers struggle to repay and investors who buy their loans become harder to find. find.
“Many low-profit, high-risk credit companies that have sprung up in recent years are likely to suffer a bit,” said Di Maggio. For those who have been prudent in their lending practices during the market boom, “there is going to be a problem as liquidity on the investor side can dry up.”
About the Author
Rachel Layne is a writer based in the Boston area.
Are fintech loans good for consumers?
Share your ideas below.