For some, recent memory can be divided into two categories: “before the meltdown” and “after the meltdown.” The meltdown, of course, refers to 2007 when a U.S. economic bubble turned into recession that ripped through the heart of America, tossed credit scores into the dirt and tightened lending practices across the industry. Suddenly, the Prime credit group became the only ones able to qualify for financing. However, as consumers become better at paying their debts, they enter a category of credit worthiness that financial institutions would be smart to court: the “Near Prime.” This subset of customers might have a blemish or two on their credit reports, yet are able to pay their debts, making them a less risky client base and potentially a highly profitable segment.
Am I Worthy?
Lenders group consumers who need financing, based on the perceived ability to pay back the loan. Post-recession however, financial institutions sought to fill their portfolio with prime and super prime customers, which, in most underwriting practices are those with a 720 credit score or above. Customers with a FICO or Equifax risk score below 660 are considered to be sub-prime. With this label come hardships in finding lines of credit. The third group is “Near Prime” and they are just in between the other two groups that may have faced some hardships but have the ability to pay. While there is no generally accepted definition of the range in which the third group falls, typically those ranging between 660 and 720 are those consumers financial institutions want to review. This group of consumers are starving for lines of credit and are able to pay, yet are being denied due to financial institutions’ post-recession tendency to be risk-averse. This is mostly due to tighter regulation and the CARD ACT of 2009, which limited scoring models and put an immense amount of pressure on financial institutions to accurately assess risk upfront to account for less pricing variability during both origination and post-origination.
Current Market Trends for Near Prime
Currently consumers with near prime credit are being turned away for reasons that are often out of their control. Sometimes a payment is missed, a job is lost or debt is consolidated to make payment more affordable. These items can stay on a record for 7-10 years. When a credit applicant is reviewed further and their history is combed over in detail, it becomes clear that these consumers are more attractive than their credit score dictates. In fact, 83% of non-prime customers today are employed, 90% have money in a checking account and 56% have a household income of $50K or more.
Today’s lenders should look beyond credit scores when making a decision to lend out money. Utilize data such as rental histories, checking account history, cellphone records and utility bills. Look at shorter periods of time, such as 1-2 years. In turn, banks may be able to put in place higher interest rates for these “Near Prime” customers than for Prime customers, ultimately graduating these consumers into the prime credit group, accompanied with lower interest rates and higher credit lines.
Expand your Base
Financial Institutions are always looking for new revenue streams and ways to expand their client base in a responsible way. This can be achieved by lending to “Near Prime” customers and can expand their base into new quality accounts. As payments are made on time and the overall credit score of the customer increases, financial institutions should automatically graduate these customers into Prime status.
Financial institutions that properly manage and price this untapped demographic can both limit their risk and potentially create a loyal, life-long customer in a win-win situation for all. After all, customers won’t forget the institution that took a chance on them when others said they were unworthy.