Lenders have always faced some level of uncertainty, but the past few years have truly put the industry to the test. While many have enhanced their systems with new enabling technologies, there are still a number of uncertainties– including inflated income due to Covid relief funds and increased spending power thanks to a student loan repayment pause– that create confusion in the underwriting process.
We spoke with PayNearMe’s Senior Director of Sales Jill Bohlken for some insight into how today’s lending environment has changed and what we can expect to see going forward into this year.
Describe the current lending environment and how it has changed over the past few years.
Jill Bohlken: In one word, the current lending environment is unpredictable. A number of converging market forces are causing some uncertainty among lenders, merchants, and borrowers alike.
We have consumer prices continuing to rise, leading to less disposable income and more borrowing by consumers to cover costs. According to the New York Fed’s Q3 report, households last year increased debt at the fastest pace in 15 years, and credit card balances collectively rose more than 15%.
Meanwhile, seven interest rate increases led to lower margins for lenders at the same time they face increased competition to attract new customers.
External forces like supply chain disruptions continue to inhibit some lending markets, such as auto. And emerging trends such as longer loan terms (upwards of seven years for an auto loan) and instant financing carry increased risk of delinquency, prompting lenders to build reserves and reduce overhead to cover themselves in case of default.
Can you discuss any notable trends or changes in consumer borrowing behavior that you have observed?
Bohlken: Last year, the economy saw unprecedented demand for goods and services driven by a surplus of Covid relief funds combined with a shortage of supply. More recently, we’ve seen loan demand start to normalize due to inflation and higher interest rates. For billers, managing risk and delinquency is always a priority. According to Experian, 60-day delinquencies for new car loans sat at 0.48% by Q3, with used car loans at 1.17%.
A more positive trend was the rise in online loan applications completed exclusively by web and mobile devices. This self-service innovation improved the speed of transactions and accelerated loan approvals, not to mention making the experience more convenient for consumers.
What tools, data, or technologies can help lenders mitigate the risk of default before extending a loan?
Bohlken: The expanding use of artificial intelligence and machine learning to analyze large swaths of data and produce actionable insights is by far the most exciting tool lenders should pursue. Payments platforms can feed a data warehouse to store transaction data in one place, then apply machine learning models to either an individual client’s data or aggregated industry data to create smarter risk models.
For instance, AI can be used to analyze cohorts of customers using hundreds of data points (zip code, income level, credit score, etc.) and assign the group a risk score. AI can even bring in data from government sources, such as unemployment and GDP reports to shed light on risk further. This research helps lenders determine how and where to find high-probability, low-risk customers and adjust their risk analysis and marketing spend accordingly.
How about once the loan has already been extended?
Bohlken: A payments provider can help lenders prevent late or missed payments using a number of tools and strategies, such as sending payment reminders by text, email, or push notification. The provider can offer a wide range of payment channels to allow customers flexibility in how they pay. In cases of chronic late payment, the provider can intervene with offers to help avoid default, such as flexible repayment plans.
What’s especially exciting is that AI and ML now make these strategies even more effective. For example, AI can be trained to constantly scan payments behavior to identify customers who have multiple late payments, then automatically initiate a series of engagement messages that move the customer toward payment. AI can also automate solutions to common payment problems. For instance, if a customer has multiple ACH returns, AI can apply a business rule requiring them to pay with cash or card only.
These automated solutions save lenders both time and money. Not only does the AI circumvent many behaviors that could lead to default, but it also eliminates the time and labor of manually resolving payment problems.
Looking ahead in 2023, will lenders be more hesitant to extend loans to borrowers?
Bohlken: It’s hard to say with certainty, but demand does remain fervent. According to a recent Consumer Pulse study, one in four Americans plan to seek new credit or refinance in 2023. However, according to Experian, auto loan balances have grown by 7.6%, so lenders may want to shore against risk, adjusting the credit profiles of their customers and trimming back-office budgets to keep a higher level of reserves.
At the same time, lenders may lean into the adage, “a bird in the hand is worth two in the bush.” That means putting more emphasis on servicing existing portfolios and maximizing return by reducing delinquency, lowering the cost to collect, and improving operating efficiency through automation and optimization.
If lenders cut back on extending loans, where will the overflow in demand go? Will consumers turn to payday loans, or will alternative lenders be able (and willing) to fill loan demand?
Bohlken: In my interactions with many large lenders I have noticed that many are reducing their workforce, a way of battening down the hatches and right-sizing operations to suit the precarious lending environment.
In terms of consumer overflow, I see movement in several “alternative” types of loans, including buy-now-pay-later, which breaks payments for a large-ticket item into several payments; and buy-here-pay-here, which allows car dealerships to act as both seller and lender. Both these options appeal to customers who may have poor credit and/or limited options for securing traditional financing.
Payday loans, on the other hand, are losing their luster after almost a decade of bad press and heavy regulatory oversight. They still play a part in some consumer borrowing, but most consumers who can find alternatives will do so to avoid the heavy interest rates and fees.