Can A New Scoring Paradigm Correct The Credit Catch-22?

Establishing a credit history can be an unexpectedly tricky thing – to get a loan consumers need to demonstrate a past history of managing with debt well. To manage debt well, entities need to extend loans to consumers. Since the inception of credit, the above catch-22 has been an issue, but under normal circumstances, it has been a solvable one.

Unfortunately, the last seven or eight years have not been regular circumstances.

While the roots of the 2008 financial crisis are myriad and complex – at its center was a lending crisis brought on by financial institutions and consumers enthusiastically working together to create a bubble in the housing market that literally flattened the global economy when it burst.

Unsurprisingly, the immediate result of the meltdown was a crackdown – both institutional and regulatory.

Lending standards became so stringent that only two types of borrowers could be guaranteed an extension of credit by a mainstream lender: prime and super duper.

Further exacerbating matters, the credit crunch didn’t just change how regulators and institutions thought about debt.

In the five years following the crisis, consumers fell rapidly and precipitously out of love with borrowing money. According to a report by the Fed, Americans not only took out fewer mortgages and credit cards – an expected result of lenders tightening up standards –  they also applied for far fewer of each. And while a large segment of that decline can be explained by consumers who a) saw their income stream interrupted as a result of the recession or b) had their creditworthiness damaged as a direct or indirect result of the recession – the report indicated that a large number of consumers were scared off borrowing.

“Since the onset of the financial crisis, households have reduced their outstanding debt by about $1.3 trillion. While part of this reduction stemmed from a historic increase in consumer defaults and lender charge-offs, particularly on mortgage debt, other factors were also at play,” the report began. “Household choices, along with banks’ stricter lending standards, helped drive this deleveraging process.”

And while a moment might have been spared four or five years ago to congratulate the American public on their newfound thrift – since profligate borrowing had tanked the entire financial system briefly- by 2012 it was fairly obvious that a credit shy economy was recovering much more slowly than expected. PYMNTS has extensively covered the SMB side of this – and how alternative lending vehicles of various descriptions are working to fill that gap – but the consumer side of the lending scene has seen a less sharp, but still noticeable decline. And those declines are particularly notable in some segments of the economy more than others.

“It seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes, thereby slowing the revival in housing and impeding the economic recovery,” then Chairman of the Federal Reserve Ben Bernanke said in a 2012 speech. “Lower-income and minority communities are often disproportionately affected by problems in the national economy, and the effects of the housing bust have followed that unfortunate pattern. Indeed, as a result of the crisis, most or all of the hard-won gains in homeownership made by low-income and minority communities in the past 15 years or so have been reversed.”

see more: http://www.pymnts.com/exclusive-series/2015/can-a-new-scoring-paradigm-correct-the-credit-catch-22/#.VSPSs5OUL6k