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Marketplace lending:
Evolution, not revolution

Dear Colleague:

It wasn’t long ago that headlines trumpeted the emergence of peer-to-peer marketplace lending as a radical threat to traditional lending institutions. We’ve all read how nimble startups, with roots closer to Silicon Valley than traditional banking, would streamline loan originations, improve credit underwriting, and create investment vehicles that would render stodgy, old-school banks obsolete.

More recent coverage, however, indicates that the red-hot marketplace lending sector may be cooling a bit. There are signs investor interest in the sector may be slowing. Some players have been racked by management upheaval. In addition, as the segment attempts to gain critical mass, regulators are beginning to give it greater scrutiny.

Let’s take a moment and reflect on the actual product that is most often being offered by marketplace lenders: the personal installment loan. 

Citibank (then the National City Bank of New York) was the first to introduce the personal loan product, in 1923. The press lambasted the bank for lowering itself to the status of a pawnbroker … yet the personal loan prevailed and eventually was considered a breakthrough for consumers. 

Among the biggest changes over the next 93 years came by way of fair-lending statutes, which were welcome developments. Then credit scoring came along, which enhanced the product and enabled automated underwriting, further expanding access and more efficient delivery. 

The most recent development, dubbed FinTech, aims to further streamline the front end of the lending process. It has not, however, fundamentally changed the profile of the product. Installment loans are still subject to funding risks, credit risks, investor risk, regulatory oversight of fair-lending practices, collection strategies, etc.

These developments don’t invalidate the marketplace-lending approach or suggest that traditional lenders can’t learn from these innovative new players. They merely remind us that the fundamentals of the lending business don’t change simply with the advent of new technologies. Innovations may bring new efficiencies and improve customer service, but it’s still essential to assess risk accurately and manage it carefully, to establish and maintain sufficient reserves, to manage portfolios prudently, and to operate with the kind of transparency that earns and preserves the public’s trust. 

Innovation, adaptation and competition can and must continue to ensure our consumer lending industry remains vibrant and resilient. We are proud to be an integral part of this innovation and increased competition, which benefit consumers. But the basic rules of lending and being repaid on time still apply. That may mean our progress will be more evolutionary than revolutionary. But what’s important is to keep moving forward, so lenders continue to gain efficiencies, while expanding qualified consumers’ fair access to credit.

All the best,

 

Barrett Burns

What do lenders think when your credit scores go up and down?

By Sarah Davies
SVP, VantageScore Solutions

recent national study by Experian and Edelman revealed that consumers are concerned about their credit scores and how those numbers impact their ability to obtain loans for major financial milestones, such as buying a home. The survey found that more than a third of future buyers believe their credit scores may hurt their ability to buy a home, and that 45 percent of respondents have delayed certain purchases to improve their credit scores. Nearly all respondents said they are taking steps to proactively change their credit behavior and improve their overall scores.

We’ve entered into an era in which virtually everyone has free access to credit scores —and the ability to track their fluctuations. This is a break from the past, when consumers only saw their scores after applying for loans. Where they once viewed credit scores as snapshots in time, consumers now see them as frames in a movie, potentially rising or falling monthly, weekly, or even daily, depending on the update frequency of their free-score providers. It’s understandable that a consumer, as confident as he or she may be about paying bills on time and managing credit wisely, could be alarmed when a score ticks downward. But before hitting the panic button, it is important to understand these fluctuations, and how lenders might consider them.

We at VantageScore Solutions examined this issue in a recent white paper and found that, yes, credit scores fluctuate often. Any downward shift in credit score can be cause for concern, but all fluctuations are not created equal, and consumers can reverse many of them quickly readily by modifying their behavior.

Using the VantageScore 3.0 model, which has a score range of 300 to 850, the study analyzed the credit scores of two million consumers over a two-year period from 2011 to 2013. The files were selected randomly from the Experian credit-file database and stripped of all personal information.

Within that two-year period, the study examined the ways in which credit scores fluctuated over three-month timespans and 12-month timespans. It found that over a three-month span, for example, 49 percent of the consumers experienced an average credit-score improvement of 19 points, while 30 percent of consumers experienced average score decreases of 24 points. Over a 12-month span, 51 percent of consumers in the study had credit score increases averaging 27 points, while 38 percent had their scores decline by an average of 34 points.

So what’s responsible for these score fluctuations? At the end of the day, they’re all related to your credit-management behavior, as recorded in the credit files maintained by each of the three national credit reporting companies (Equifax, Experian and TransUnion). Your credit files reflect all of your account payments, including whether the payments were made on-time or late; your credit limits and outstanding balances; and the total number of open accounts you have and how long you’ve had them. Your credit files may also indicate if you have experienced personal bankruptcy, financial judgments, tax liens, or other negative events.

Model developers use advanced statistical analysis to identify behaviors (and combinations of behaviors) that indicate your risk of default (which is defined as becoming delinquent for 90 days or more). Behaviors that indicate greater risk can cause scores to decline, but credit scoring models recognize that not all risk-related behaviors are equally detrimental. Those deemed relatively insignificant result in small score shifts, which are short-lived, while those that are viewed as being more serious result in large shifts that are longer lasting.

When managing personal credit, it’s important for consumers to manage the score-lowering behaviors that are are quickly reversible, and to avoid events that have longer lasting impact. For instance, changes in credit-usage levels (the percentage of available credit a consumer uses), are relatively easy for a consumer to control: Using a high percentage of available credit, or even “maxing out” credit cards, can cause significant declines in credit scores, but scores will rebound quickly as those cards are paid down and usage levels are reduced. (VantageScore Solutions recommends keeping usage levels at or below 30% of the available limit.)

In contrast, events that become part of your credit history—such as late payments, or debts that are sent to collection agencies—remain in credit files for years. Their negative credit score impact diminishes over time, but much more slowly than the dips caused by occasional (and temporary) use of high percentages of available credit.

Impact on score-based decisions

The VantageScore study looked at the effects that the fluctuations in credit scores would have with respect to a typical “score cut-off” – a score value that lenders might use as a threshold for accepting loan applications. Using a cut-off of 620, VantageScore found that 6.4 percent of the total population would have received the opposite decision if their score had been reviewed three months later.

That means that some consumers who are turned down for loans today might have better luck in a few months’ time—and it also means some borrowers who squeaked by a few months ago might not be eligible for a loan today. Individuals who fall in either camp would do well to be vigilant about their credit habits, for example, by taking care to make payments on time and to avoid running up high account balances.

Such vigilance makes sense because lenders do more than just check your credit score, or act upon it, at the time when you apply for credit. Lenders, particularly credit card issuers, generally monitor their customers closely and regularly. They rely on many types of data, including credit scores, for such monitoring. Lenders ultimately base credit scoring-related decisions on whether a single score threshold is met at a given moment in time. But which score threshold applies to a particular consumer, and which actions are taken when that threshold is crossed, can depend on tendencies over time, including credit score trends.

What constitutes a “major” credit score fluctuation is in the eye of the beholder, but for VantageScore 3.0, a useful threshold is plus or minus 40 points. If a consumer’s credit score drops by 40 points, that indicates that the odds of that consumer defaulting have doubled. If, on the other hand, a consumer’s credit score increases by 40 points that indicates that the odds that the consumer will default have decreased by half.

Declines of fewer than 40 points are often the result of day-to-day credit management actions, which do not necessarily reflect a substantial increase in risk exposure to a lender. In other words, consumer activities like authorizing credit inquiries (when applying for credit, for example), opening new accounts, or temporarily increasing usage of available credit limit, might cause short-term score drops, but such activities are not necessarily the red flags that would cause a lender to reduce a credit line or take some other sort of mitigating action.

By contrast, larger, longer- lasting declines in credit score typically occur when a consumer pays bills 30 or 60 days late, or when more catastrophic events such as bankruptcy or a legal judgment appear on a credit report. These credit behaviors have a greater impact because testing has shown that consumers who act in this manner are more prone to default. A lender is much more likely to take mitigating action in such cases.

This is how lenders might deal with score fluctuations, but what is the lesson for a consumer?

Score fluctuations of 40 points or less are fairly common and, as the saying goes, slow and steady wins the race. There is no need to panic about small score fluctuation as long as you continue to practice good credit behaviors, like paying bills on time. If you see a larger decline in your score and you know you have been managing your credit appropriately, check your credit reports to make sure that there are no errors or other information that might indicate that you have been a victim of identity theft.

For more information, go to www.yourvantagescore.com.

Trade-level derogatory entries in your credit file, and why to avoid them

Many kinds of entries on a credit report can lower your credit score, but some are much more harmful than others. The entries that do the most damage and that tend to keep your score down for extended periods of time are what lenders call derogatory events—or just plain bad ones. (For a refresher on credit reports and how they are organized, see our Anatomy of a Credit Report series.)

Lenders view derogatory credit-report entries as evidence of mismanaged debt. That is why credit-scoring models typically treat them as grounds for steep, long-lasting score reductions. That is also why you should avoid them at all costs. This four-part series of articles is designed to help you “steer clear” of derogatory events, examining them in detail so you know what to avoid—and what the consequences could be if you don’t. We are covering the three categories of information that can be considered derogatory: The first part examined public records; part two looked at credit-report narratives, this installment and part four will look at the somewhat complicated topic of non-performing trade lines—a fancy term used to describe accounts that aren’t being paid as agreed upon. 

By John Ulzheimer
The Ulzheimer Group

Trade, as used in the credit industry, refers to an account on your credit report. So, a Bank of America credit card on your credit report, would be referred to, formally, as a trade line. A trade line can contain a variety of negative entries, including current and historical late payments, past-due balances, and indicators of default or other serious delinquency associated with the account. This month we’re going to tackle historical late payments.

Just for clarity, a late payment on a credit report isn’t the same as a late payment on an account. I know that doesn’t make any sense, so let me clarify. In order for you to be late on one of your credit accounts, you have to not make a payment on or before the due date. In order for a late payment to show up on your credit reports you have to be a full 30 days past the due date. So, if a late payment shows up on your credit reports, then you know you went at least 30 days late, not just a few days late. In other words, there’s a more rigorous standard used in credit reporting.

For the past several decades the three national credit reporting companies (CRCs—Equifax, Experian and TransUnion) have accepted late-payment reporting by creditors. So, if last year you were late on your credit card account by 30-59 days multiple times, it’s likely a record of those previous late payments will appear on your credit reports, associated with each respective account. And yes, those late payments do have the potential to lower your credit scores.

There are a variety of ways historical late payments are represented visually on credit reports. The most common is for the credit reporting companies to display a payment-history grid for each account, which indicates if you’ve made any late payments, how many days you were late, and when you were late. The grids may appear differently depending on which national credit reporting company (Equifax, Experian or TransUnion) supplied the report you’re viewing. This chart shows a common example:

Payment history grid showing a late payment


This particular payment history grid indicates that the consumer was 30 days late on a payment in January 2012. It also indicates that the account was paid on time every other month in his or her credit reporting history. That particular 30-day late payment can remain on the consumer’s credit report for seven years, or until no later than January 2019.

Obviously, you’d like your payment history grid to be clear of any record of late payments, like the following example. This grid is void of any late payments and indicates that the account has been paid on time for the time period covering June 2011 to April 2016:

Account history grid with no late payments

Next month, we’ll take a deeper look at trade-level credit-report entries, and additional types of records to avoid.

Did You Know what happens to collections once you’ve paid them?

Collection accounts are derogatory credit report entries that have long been a part of the credit reporting landscape. They occur when a debtor defaults on some sort of obligation with a creditor, service provider or property manager. Collections are never fun to deal with because they can often lead to lower credit scores. 

According to the Fair Credit Reporting Act (FCRA), collection accounts can be legally reported by the three national credit reporting companies (Equifax, Experian and TransUnion) for as long as seven years from the date of the original default. So, for example, if you defaulted on an apartment lease in June 2013, any subsequent collection account stemming from that default could remain on your credit reports until June 2020.

There’s a widespread misconception that collections accounts must be deleted from credit reports once they have been paid off in full. That is not true: If you pay or settle a collections account, the only obligation on the debt collector and the CRCs is to update the account to show it now has a zero balance. At the present time, there is no obligation for the debt collector or the CRCs to remove the collection account simply because it has been paid, settled and now has a zero balance.

The news, though, gets better from there. Some of the newest credit scoring models, including VantageScore 3.0, the latest version of the VantageScore credit model, ignore collection accounts with zero balances in the calculation of credit scores.

Keep in mind, however, that the collection is still displayed on the credit report. And despite the fact that it may not affect your credit score with some of the newer models, lenders could nonetheless consider it as a matter of policy. Further, older credit scoring models, such as those still widely used in mortgage lending, continue to consider collection accounts of all types, even those with zero balances. 

Models that consider zero-balance collections accounts in score calculation typically treat the accounts as derogatory entries. Thus, they can still have an adverse impact on credit scores and can cause either credit declinations or approvals with less favorable terms. This underscores how important it is for lenders and others to convert to the newest versions of credit scoring systems because they’re more borrower-friendly in their treatment of collection accounts.

Five Questions with Patty Arvielo, president, New American Funding

With more than 30 years of mortgage experience, Patty Arvielo is co-founder and president of New American Funding, a national mortgage bank. She leads all sales and operations at the company, and still makes time to originate individual loans. 

She also serves on affordable lending panels for Fannie Mae and Freddie Mac, on the Diversity and Inclusion Committee and the Consumer Affairs Advisory Council for the Mortgage Bankers Association (MBA), and on the Corporate Board of Governors for the National Association of Hispanic Real Estate Professionals (NAHREP). Passionate about improving lending services for the Hispanic community, she created her own Latino Focus Committee to identify and address challenges Hispanic consumers face in their pursuit of homeownership. Patty’s life story, “I Am My Mother’s American Dream” was recently featured at NBC Latino.com, and she is a finalist for Ernst & Young’s Entrepreneur of the Year® award. We at The Score are grateful Patty took time from her very full schedule to share a few thoughts.

This year, you’ve been recognized for many successes, one of which is a finalist for Ernst & Young’s Entrepreneur of the Year®. What lessons have you learned about starting your own business that are important to pass down to the entrepreneurs of tomorrow? 

Nobody is going to tap you on the shoulder and ask you to be successful. That drive comes from within. Imagine what you want, dream big, then chase your vision. It’s up to you to create your success.

You began working at age 16 as a clerical data input clerk at TransUnion. What was that experience like? 

I’ve always been a hard worker, and at first, I was just doing the job in front of me. Of course, that didn’t last long and my drive to do more, and be more, took over. I saw that if I wanted to be in a position of stability, where I could provide for my family and myself, I had to make more money. I was propelled by an undying work ethic. I taught myself this business, and then I climbed the ranks. 

You’ve said in the past that diversity and inclusion are a part of why your business is so successful. What are some ways you propose the industry can embrace these same values when it comes to — literally and figuratively — opening more doors to more consumers? 

We need to look ahead and become a reflection of our markets. America is going to be more culturally diverse than it has ever been. Soon we will see a minority-majority with Latinos. We’re going to see more Latinas in decision-making positions in the household, more integration of technology in day-to-day decisions, different value sets, and more buying power among multi-generational consumers. Our industry and our workforce need to reflect all of those traits. It is more than just having the numbers in your staff; it is about having these diverse viewpoints in positions that can effect change. 

Knowing the Hispanic-American market so well, what counseling do you find is most beneficial to these audience members when it comes to preparing them for homeownership? 

Educating Latinos on today’s programs is especially important. We need to raise awareness about homeownership possibilities and undo old ideas about what it takes to buy a home. The need for a large down payment is a common misconception, so breaking down myths like that, while explaining the home buying process and providing financial documentation tips, is key. 

New American Funding launched in 2003 and grew rapidly while also having a front seat to the real estate bubble’s collapse because of its California roots. What about the crisis remains on your mind as you continue to grow the business?

The collapse taught me about risk and reward in ways I had never imagined. Mortgage businesses around me were collapsing and I was running a company — without receiving a paycheck for a year and a half. For me, it reinforced what I already knew; if I stay true to my values and do things the right way, things won’t go wrong. 

Tenth Anniversary Top 10:
Topic searches

2016 marks the 10th anniversary of the founding of VantageScore Solutions, LLC. To commemorate that milestone, each 2016 issue of The Score newsletter will include a bonus “Top 10” article. This month, we offer a look at the 10 most popular topics searched by readers of the newsletter.

Rank

Search topic


10

Obtaining credit scores


9

Validating credit scoring models


8

Five Questions


7

Did You Know?


6

Consumer credit behaviors/attitudes


5

Credit industry trends/regulations


4

About the VantageScore models


3

What impacts credit scores


2

Credit score accuracy


1

Interpreting credit scores



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