Conventional wisdom holds that providing a new loan to a currently delinquent borrower is not generally a profitable idea—“throwing good money after bad,” some would call it. A recent study* conducted by TransUnion challenged this truism, suggesting lenders may want to revisit their lending guidelines. The study found that, in some instances, both lenders and delinquent borrowers mutually benefit from an injection of liquidity via an unsecured personal loan.
While still well below recessionary levels, borrower delinquency has grown in recent years. According to TransUnion’s Q3 2019 IIR, in September 2019 1.81% of bankcard consumers were late by 90 days or more on their bankcards, up from 1.71% the year prior. For lenders, this uptick stresses the importance of active account management and a deeper understanding of how to best serve struggling borrowers. Forgetfulness and over-borrowing are two commonly discussed triggers of borrower delinquency; however, a sudden acute situation, such as a car accident or short-term reduction in weekly work hours, can have a similar impact. In an ideal world, understanding the underlying cause of delinquency should drive lender treatment. For example, forgetting to pay a bill, which TransUnion identified as the issue with 46% of bankcard delinquencies and nearly a third of auto delinquencies in 2018, may resolve itself with a simple borrower reminder like a (relatively inexpensive) statement message. Alternatively, bringing an overextended borrower current becomes more challenging, and can be significantly more expensive operationally.
TransUnion’s study focused on the struggling borrower, defined as those late on at least one payment for consecutive months, or hitting 60+ days past due in a given month. The goal was to identify if a struggling, delinquent borrower would cure an existing delinquency if extended additional credit via an unsecured personal loan. TransUnion compared delinquent borrowers with a VantageScore® 3.0 credit risk score of 660 or below, half of whom originated a personal loan and half of whom did not. Only borrowers considered recoverable, which the study generously defined as holding an early stage delinquency of 30-119 days past due, were included. To best simulate the strict criteria many lenders maintain, borrowers with a bankruptcy or charge-off on file in the past two years were also excluded.
The findings were unexpected. In total, 24% of delinquent borrowers who received a new unsecured personal loan cured at least one of their existing delinquencies within two months of receiving the loan and never missed a payment on the new loan in its first year. For these borrowers, an injection of liquidity via an unsecured personal loan appeared to help them overcome a financial struggle in a sustainable manner. This presents a potential method for lenders, outside of deferment or hardship, to support borrowers when they encounter a sudden, short-term acute financial constraint. That is not to say lenders should rush to lend to a delinquent borrower just because of a complaint related to a short-term struggle—69% of those borrowers studied who received a loan did not recover on their existing delinquency, and a quarter of those went delinquent on the new personal loan as well.
The key is for lenders to be judicious. A critical finding of the study was that the targeted 24% of consumers who cured and maintained positive performance on the new loan (“cured and paid”) could be predicted with some success at the time of loan origination using both traditional and trended credit attributes. For example, and controlling for credit score, these borrowers tended to be seasoned credit users with fewer recent inquiries. Those delinquent borrowers with an open credit line or loan at least ten years old and/or an average of eight or more active accounts at the time of origination tended to achieve the optimal “cured and paid” scenario. Delinquent borrowers with 12-15% of their wallet held in revolving accounts, most frequently credit cards, also fit this profile. This latter dynamic may be attributed to the fact that credit cards are one of the first products on which consumers go delinquent and also easiest to cure given lower minimum payment requirements.
Beyond an unconventional approach to curing a delinquent borrower, these findings also stress an important lesson from an acquisition perspective: While delinquent borrowers represent a higher risk, it is not safe to assume all delinquent borrowers will default on a new loan. In the study, TransUnion found less than a quarter of borrowers currently delinquent on one or more accounts were late on a new account payment in the originated loan’s first 12 months on the books. That includes even the riskiest of borrowers. When looking at a random sample of borrowers opening new accounts in 2017, only 23% of subprime* consumers who were late by 60 days or more were also late on their new loan or line of credit in its first year. While this certainly represents higher risk than non-delinquent peers, it is not all currently delinquent borrowers. Over three quarters of delinquent subprime borrowers studied made all payments on their new loans in the first year—and these are borrowers who might otherwise have been overlooked by existing lender criteria. Charge-off rates on new loans were also relatively similar between borrowers with existing delinquency and those without, again controlling for traditional credit scores. In fact, near prime* borrowers charged-off on new originations at the same rate regardless of whether they were delinquent or current at the time of loan origination.
In conclusion, lenders may want to review their existing treatment strategies for delinquent borrowers. Certain distressed borrowers will improve on an existing delinquency with the addition of a new loan, which can lead to a win-win for consumers and lenders. While this often comes in the form of profits to the lender, either via positive payment performance of the new loan or recouping potential losses on delinquent accounts, it also has the potential to increase customer loyalty. For anyone going through a sudden, acute situation, a helpful hand at a time of need often garners a deeper respect and appreciation. In a constantly evolving environment, pausing to re-examine criteria and consider innovative, new methods to helping struggling consumers may very well help lenders and borrowers alike.
*Subprime borrowers are defined as individuals with a VantageScore 3.0 credit risk score of 600 or below; Near prime borrowers hold a VantageScore 3.0 credit risk score between 601-660.
**TransUnion Study: The Delinquency Gambit: Help or Hindrance?
About the Authors
Matthew Komos leads financial services research and consulting in the U.S. for TransUnion; Kristen Bataillon is charged with providing insights to TransUnion on recent trends in the lending industry and consumer credit risk management.