A new blog post from the Consumer Financial Protection Bureau (CFPB) suggests serious consideration should be given to a new method for determining a person’s ability to repay loans. Lenders should no longer rely on credit reports alone.
Three CFPB researchers report cash flow data (broadly defined as various inflows, outflows, and accumulated amounts in checking and savings accounts) may provide lenders with more information about how applicants manage current obligations than they could learn from applicants’ credit repayment histories alone.
The evidence, researchers say, suggests that cash flow data may help lenders better identify borrowers with a low likelihood of serious delinquency, even if their credit scores may have otherwise prevented them from receiving credit.
Mortgage credit has been tightening to levels not seen in nearly a decade, which makes attaining a home even more difficult using existing credit standards. “Mortgage credit availability was essentially unchanged in June, remaining close to the lowest level since early 2013, as the industry continues to operate at reduced capacity,” said Joel Kan, deputy chief economist for the Mortgage Bankers Association, which conducts a monthly credit survey.
The research uses the CFPB’s Making Ends Meet survey and the linked Consumer Credit Panel (CCP) to show that three self-reported proxies for cash flow appear predictive of serious delinquency, even when analyzing people with similar traditional credit scores. The three proxies the researchers used are high accumulated savings, regularly saving and no overdrafts, and paying bills on time.
The analysis suggests that people who self-report positive cash flow perform considerably better than those who self-report less positive cash flow, even when holding credit scores constant. Based on the cash flow proxy used, consumers with positive self-reported cash flow outperform by 20% or more.
The blog post outlines three cashflow proxies: high accumulated savings, regularly saving and no overdrafts, and paying bills on time. In high accumulated savings proxy, it appears that people with positive cash flow are less likely to be seriously delinquent in the future. In the proxy for people regularly saving with no overdrafts, it is close to 40% more likely they will not default in the first two years of their loan. The number is 20% for the third proxy of people who reported no trouble paying their bills.
The report’s authors are Alexei Alexandrov, a CFPB fellow; Alyssa Brown, a CFPB economist; and, Samyak Jain, a CFPB research assistant. They concede their study might need more data. They wrote, “Though our results suggest that using cashflow data may improve underwriting, there are two major caveats: our effective sample size is small (only hundreds of consumers), and the cashflow measures are self-reported proxies. We focus on people with credit scores under 720 (below the superprime segment) because people with superprime credit scores are very unlikely to become seriously delinquent, so there is a smaller margin for cash flow data to be informative.
