Getting a loan based on your credit score is so old-fashioned.
Over the last few years, a number of technology startups have created ways to underwrite loans that don’t rely on the traditional methods. To evaluate the factors that go into administering a loan—identity, fraud risk, credit worthiness—the startups look at mishmash of seemingly tangential information about applicants, such as activity on their social network profiles, how often they use their cell phones, and whether they frequently send text messages.
The startups argue that this constellation of data can better (as in faster, more cheaply, and more accurately) hone in on whether the applicant can replay the loan by analyzing how they live, the decisions they make, and how they interact with others. If it all checks out, the cash is transferred to users within minutes of applying for the loan.
Loans are typically in the hundreds of dollars, although some startups would like to increase the size they gain users and better establish the creditworthiness of their borrowers. Regardless, there is a steep price for people who use the services: Interest rates can sometimes go as high as 30% on the transactions.
co-founder Max Levchin is one of the leading voices in the movement. In 2013, he founded Affirm, a company whose technology combs through a wide range of sources to help decide if applicants should receive loans.
Its technology scans a person’s profiles on social networks to check for clues about how they live their lives with hope that what seems irrelevant may be useful in underwriting a loan. For example, Affirm wants to know whether a potential customer has contributed software code to digital code libraries like GitHub. What does that tell it? That the customer is who he or she says they are. Other metrics can help assess his or her ability to repay a loan. (Like other companies in the market, Affirm is tight-lipped about how those data points specifically factor into a credit decision, to safeguard its algorithms against snooping competitors.)
“It turns out there’s lots of data there about someone, and a lot of it is completely relevant,” Levchin told Fortune in an interview last year.
Like several other companies, Affirm is trying to appeal to millennials who inherently don’t trust big banks and want to secure financing in new ways.
“As people graduate from college, they may have to put a deposit down on an apartment,” Levchin told Fortune in March. “They’ll need a car or a real bed. These are all credit decisions.”
He continued: “People ages 18 to 34 are predisposed to hate banks. They want financing, but hate paying interest—hate the idea of being stuck in debt. But they’re willing to pay a fee upfront to split a payment over several months. We can underwrite people that the system sees as terrible risks with better clarity.”
ZestFinance, another startup, is using big data to make credit decisions. Rather than using simple credit checks, the company looks at certain variables on a credit report along with how people use smartphones and social network.
ZestFinance says that its use of bulk data collection delivers a 40% improvement in default rates over current industry scoring methods. The company didn’t provide its typical default rates.
“ZestFinance analyzes thousands of potential credit variables—everything from financial information to technology usage—to better assess factors like the potential for fraud, the risk of default, and the viability of a long-term customer relationship,” the company says.
While some companies are focusing on younger borrowers, others are also focusing on emerging markets. One such company, InVenture, told the Wall Street Journal on Monday that it provides a much-needed service to people in several countries in Africa, where credit scores don’t exist and loans are rare.
According to the Journal, people looking for loans can install InVenture’s app a mobile device. The app then tracks how they use their phones. Sending too many text messages or a low battery may be a sign that an applicant is a credit risk, based on historical data it has collected and analyzed, the company’s CEO Shivani Siroya told the Journal. In contrast, people who make more calls at night or use gambling sites may be more credit worthy. Those activities suggest price sensitivity (calling rates are lower at night) and, in the case of gambling, an ability to pay debts.
Another mobile startup, Branch, uses a similar method. According to the company’s website, after users log into its mobile app, it can determine their creditworthiness based on “SMS logs, call logs, and contact lists.” Like InVenture, Branch believes that how people interact with others may ultimately determine their likelihood to repay a loan.
“Your digital trail can establish your financial track record,” Branch founder Matt Flannery told the Journal in an interview.
While the idea is certainly interesting, the startups have a long way to go to become the new standard for credit checks. The vast majority of those checks performed by credit card companies, automakers, and big banks, all rely on traditional credit-tracking agencies and FICO scores.
In an interview with Fortune in October, Affirm’s vice president of merchant services Brad Selby indicated that his company’s roll-out to stores may take some time. For now, Affirm is available only to retailers with which it has partnered. To help get more, Affirm has signed up with Shopify, a popular e-commerce software provider that powers many online marketplaces. The company has also inked a deal with Clover, a point-of-sale system, to increase its presence in brick-and-mortar stores. Like its competitors, however, Affirm has yet to secure many major retailers to work with its service.
In emerging markets, including Kenya, the issue may be even greater: Companies need to get users to download their applications to mobile devices to analyze information. In those markets, smartphone use is low compared to developed countries like the U.S., though there are signs of a significant uptick in usage in most areas. Time, patience, and money, may ultimately prove most important for the startups.
For now, then, the new age of securing a loan is very much in its fledgling stages with no indication of whether it will be successful. Given the hundreds of millions of dollars poured into the market, however, venture capitalists seem to see a future. Questions remain, though, over how consumers will ultimately react to seeing their social networks and mobile phones analyzed to determine whether they can buy that new car.
Clarification, Dec. 31, 2015: This story has been updated to clarify how Affirm uses different metrics to underwrite loans.
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