January 13, 2016
Social Finance Inc., a San Francisco company, has decided to do away with FICO scores in its student loan refinancing, mortgage and personal loan offerings decisions.
The platform had been running a pilot non-FICO lending scheme that began in the fall of 2015, announcing that the pilot operation will now become the norm. The platform will henceforth consider three criteria—employment history, the track record of meeting financial obligations, and monthly cash flow minus expenses—to determine if an applicant is qualified for its loan products, which include student loan refinancing, mortgages and personal loans.
Banishing traditional credit scores stems from SoFi's belief that the FICO model is flawed and outdated; it's less of an indicator of how a borrower will behave in the future, but rather, a reflection of past behavior. Having now funded more than $6 billion in loans, SoFi is the first large lender to become an entirely "FICO-free zone."
The online lending space is famed for its innovative approach to credit. Evidence comes in the form of the recent collaboration between JPMorgan Chase & Co. (the biggest US bank) and OnDeck Capital Inc. to dramatically speed up the process of providing small business loans to some of the lender’s 4 million customers. The product will be offered under the Chase brand and is expected to be piloted next year with small dollar loans under $250,000.
"Our approach to underwriting is based on transparency and balancing the needs of our members and investors, and we found that the FICO score was anything but transparent. So we threw it out," said CEO and Co-founder Mike Cagney in the press release. "We're proud to be the only major lender that does not use the score for any lending. Instead of relying on a three-digit number to tell us who's qualified, we look for applicants who have historically paid their bills on time and make more money than they spend. It's that simple."
A recent survey commissioned by Bankrate and compiled by Princeton Survey Research Associates International found that 63% of millennials aged 18 to 29 don't have a credit card, showing that credit scores are becoming less relevant for this generation. The industry at large is also examining the accuracy of FICO; if passed, the Credit Score Competition Act of 2015 will allow Fannie Mae and Freddie Mac to use credit scoring models other than FICO.
"Credit scores don't provide an accurate picture for financially responsible professionals with a strong employment history and monthly free cash flow," says Dan Macklin, SoFi Co-founder and Vice President of Community & Member Success. "These scores tend to be inaccurate, hard to dispute and even harder to pin down, with the onus falling to consumers to monitor multiple databases. We're more interested in a comprehensive and forward-looking approach to assessing an applicant's financial wellness."
A variety of smaller Silicon Valley-backed companies has also started building affordable and transparent alternatives to old-school credit cards.
Affirm’s installment payments product is hugely beneficial for people who primarily use debit cards and have not developed FICO scores. The company also addresses the requirements of people with low credit scores and people whose credit score has been hit during the financial crisis. Users who want to use Affirm can sign up at the checkout by filling in information, including name, mobile number and date of birth. Affirm pays Web retailers in full when consumers check out, then lets the consumers pay the balance 60 or 90 days later. In most cases, the interest starts at 6%, while merchants pay a transaction fee of 2% to 3% of the sale amount. Multiple online retailers who have partnered with Affirm have also realized the benefits. They have witnessed a significant jump in average order value.
Getting a loan from Earnest does not require a FICO score. They look at your bank account and see how you manage your monthly cash flow. It might be possible that a user with a high FICO score can use credit to pay credit. So if a company looks at his/ her monthly cash flow, it would give the company a better view of his/her creditworthiness. Earnest clearly states that it will turn down an applicant with an 800 FICO score if they find that the person does not manage the cash flows properly.
Avant, one of the nation’s fastest growing marketplace lending platforms, has played down the usefulness of assessing applicants based on FICO scores. It requires borrowers to have a minimum FICO score of 560, but after they pass that hurdle, the score isn’t given any weight in the company’s credit models.
From day one, our premise was to engineer a better analytical model than the traditional, said Al Goldstein, Avant’s Chief Executive.