In lending, there are two dominant errors.
The first happens with a borrower who doesn’t seem creditworthy, but turns out to be an excellent borrower.
The second type of error happens with a borrower who appears to be an excellent candidate for a loan, but instead goes into collections or default.
The difficulty of determining which type of borrower you’re dealing with before you approve a loan is a major obstacle to loan profitability.
Modern loan applications and underwriting attempt to solve this challenge. But any lender or creditor can tell you that write-offs and borrower churn are just a fact of life.
Or are they?
At Bankuity, we’ve learned through extensive data analysis that there are two primary levers that you can pull to improve loan profitability: optimizing loan amounts and identifying the correct payment schedule for each borrower.
In this article, we’ll explore how these two levers operate and how your credit operation can take full advantage of them.
The Cost of Inaccurate Loan Amount Decisions
When you misjudge a borrower’s risk and lend them too much money, the costs aren’t isolated to the write-off.
You lose time and money trying to collect on the loan and going through default proceedings. A defaulted borrower also represents a relationship that’s very difficult to salvage. You may never see them, let alone your money, again.
Conversely, when you under-lend to a low-risk borrower, you create hidden costs that drag down overall profitability. One is sub-optimal capital deployment, resulting in the need to go out and find additional borrowers to fill the gap.
And when a borrower doesn’t get enough capital to address their needs, they may seek out additional creditors to cover the remainder. Instead of being the lender who fixed their problem, you’re the hard-nosed lender who forced them to take out another loan or line of credit.
Both of these scenarios lead to dissatisfied customers, unnecessary expense, and extra work for your lending team. That’s the status quo for many creditors.
It doesn’t have to be yours.
Optimize Loan Amounts
Discerning the right amount of money to lend isn’t a new concept, but few organizations have access to the data and analytical tools they need to do it well.
Worse yet, they don’t even realize they’re making mistakes or how much those mistakes are dragging down loan profitability overall.
Hitting the bulls-eye for lenders means correctly assessing risk and right-sizing loan amounts.
Exposing Hidden Obligations
Not that long ago, lenders relied on the honesty and thoroughness of would-be borrowers during the application process.
Today, digitized bank accounts and financial accounts give lenders a clearer picture of each borrower and where their money is going on a monthly basis.
However, transactions still slip through the cracks, and some types of credit (until recently, buy now pay later agreements were a major factor) don’t show up on credit reports.
What lenders need is a tool, such as Advanced Bank Verification (ABV™) technology, that can automatically comb through an applicant’s transaction history and correctly identify debt payments regardless of source or type.
Verifying True Affordability
With the rise of gig workers and non-traditional income sources, such as Uber, DoorDash, Etsy, and Patreon, among others, obtaining a complete picture of someone’s income is more challenging than ever.
Lenders and underwriters often analyze these types of borrowers according to a traditional framework for debt-to-income ratio, which tends to mark them as high-risk or ineligible. That’s a missed opportunity for your loan portfolio.
It’s far better to use a comprehensive affordability score that weighs income and spending patterns to deliver a precise loan value recommendation for each borrower.
Reducing Unexpected Defaults
Missed payments and defaults happen. The first, and most important, preventative step you can take is to correctly match the loan amount to the borrower’s ability to pay.
Next, you need a holistic process that can help you manage non-performing loans from the first sign of trouble.
If you can quickly identify when a borrower is in trouble and communicate on their terms, it’s possible to achieve a much higher rate of payment recovery, according to a study by McKinsey.
Manage Payment Date
One of the most overlooked ways to improve repayment and loan profitability is to synchronize the due date with the borrower’s income patterns.
The closer you can align the two dates, the lower the risk of default or missed payments.
Matching Debit Date to Income Deposit
When a borrower’s debit date and income deposit date are out of sync, it tends to increase first payment default (FPD) risk—a key credit risk metric.
In the data from our lending clients, Bankuity was able to identify 40% of existing borrowers with poorly synced debit and income dates. By correcting this mismatch, our clients saw a 5-20% decrease in FPD, depending on how close they could align the dates.
Although this kind of correction can be helpful retroactively, it’s far more effective when you integrate the analysis into the application and underwriting process.
ABV technology can allow you to process an applicant’s data very quickly and generate recommendations for the best loan payment dates to offer as due/debit options.
Establishing Best Debit Frequency
Monthly loan payments may be the most common, but there’s plenty of precedent for increased debit frequency as a way to help borrowers pay off their debt.
The best case scenario is to find a win-win solution, optimizing cash-flow for your organization and identifying the payment cadence that will help your borrowers succeed. A full-term borrower is good, but a satisfied borrower who becomes a repeat customer is even better.
Monitoring Income Changes and Calibrating Collections Timing
Many lending applications are based on the current state of the borrower’s income, but 27% of borrowers experience a change in income between the loan approval and their first payment.
With a tool like ABV technology, you can monitor a borrower’s income patterns after the loan gets disbursed and proactively communicate when there’s cause for concern. This increases your chances of setting up alternative payment arrangements with the borrower.
For situations where you need to engage in collection activity, it can be very helpful if your system can analyze real-time transaction data to identify when the borrower is most likely to resume repayment.
Turning Loan Profitability Into a Hard Science
The lending and credit business is driven by numbers, but some people rely on outdated systems or intuition for key decisions.
That’s not the way to generate loan profitability in the long term.
You need a system that can digest and transform millions of transactions and data points into a coherent framework for borrower assessments.
The Bankuity platform uses artificial intelligence and machine learning to help you conduct faster, more accurate borrower assessments and choose the optimal loan amount for any borrower.
Our ABV technology supports your lending operation throughout the borrower lifecycle, mitigating risk and increasing the likelihood of winning repeat business.
To learn exactly how ABV can improve loan profitability at your company, schedule a demo today.
