Fintech ramped up lending to low-income consumers

Financial technology firms have been ramping up lending to a group of consumers that traditionally have gotten short shrift from traditional financial services providers, like banks. A new report from the Federal Reserve Bank of New York revealed the explosive growth in fintech lending to low- and moderate-income consumers. But it also cautions that rising delinquencies could test the mettle of borrowers and lenders alike.

"Fintech models for lending offer an important alternative to higher-cost traditional credit that is often inaccessible to low and moderate-income borrowers and less secure small-dollar loan options. An environment of lower interest rates allowed fintech firms to grow their businesses in the unsecured lending space," the report stated. "However, as inflation rose and interest rates tightened, delinquencies began to rise in this space."

In a separate report, the New York Fed said delinquency rates for nearly all types of consumer loans have risen from the rock-bottom levels seen in 2021 and 2022, when the economy was flush with pandemic cash. Aggregate delinquency rates rose 3 percent in the third quarter.

The only categories of loans that did not experience increases in delinquency rates, researchers noted, were student loans and home equity lines of credit. The "other" category of loans, which includes many of the nontraditional loan products fintechs offer, saw 5.78 percent of loans "flow into serious delinquency" of 90 days, or more.

Seeing the writing on the walls, some fintechs are tightening underwriting standards and cutting back on loans to low- and moderate income consumers. They also have been diversifying their businesses to include offerings like cash-flow management and financial health and savings products, according to The role of fintech in unsecured consumer lending to low- and moderate-income individuals.

Published in November 2023 by the New York Fed, the report used 2022 and 2023 credit insights data from TransUnion and data from the online lender Prosper for insights on different types of loans to different income groups. It also incorporated interviews with fintech lenders in the space.

$232 billion in unsecured credit

Americans had amassed $232 billion in unsecured personal loan balances as of mid-year 2023, a $40 billion increase since 2022 and $86 billion more than the 2021 total, the New York Fed found. In all, 22.7 million U.S. consumers are paying down these balances. (By comparison, there are 166 million Americans with at least one credit card, and total outstanding balances on credit cards exceeds $1 trillion, Fed data revealed.)

"The increase in personal loan originations was especially pronounced for borrowers with lower incomes and those in the below-prime category. Loans to consumers with below prime credit nearly doubled by 2022," the report stated. "By 2022, the share of borrowers with below prime credit scores reached 66 percent."

A prolonged low interest rate environment, coupled with the efficiencies of online lending, made it possible for fintechs to reach consumers who find it hard to get loans from traditional lenders.

To accommodate the thin or nonexistent credit histories of many of these borrowers, fintech firms have adopted alternative data and underwriting methods that aren't employed by banks and credit unions. Alternative information, such as rent and utility payments, peer-to-peer lending history and social media, can provide a clearer picture of a consumer's risk profile, fintech companies have discovered.

However, inflationary concerns and rising interest rates have combined to force some fintechs to pull back on lending to low- and moderate-income consumers.

"Fintech firms will continue to be tested in their ability to consistently provide [low- and moderate-income] borrowers with an alternative credit option, particularly in economic environments that are difficult for [low- and moderate-income] borrowers to navigate," the New York Fed stated.

"Caution should also be taken with the use of alternative data in such economic environments, given low- and moderate-income] borrowers' likelihood of facing financial shocks that will affect their cash-flow management and their ability to make [utilities, telephone and rent] payments on time," the New York Fed added.

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