Garnet Capital Advisors Blog

Concerned that traditional underwriting methods are leaving some would-be borrowers behind, peer-to-peer lender Upstart has responded by developing a unique process to vet credit applicants.

The Palo Alto, California-based company connects investors with individuals who finished undergrad or graduate school after 2008, The New York Times reported. Would-be borrowers can obtain money to fund a business, pay off credit card debt, take a course or finish their degree, according to the company website.

Comprehensive applicant profiles
To vet applicants, Upstart compiles a comprehensive applicant profile by asking individuals for their alma mater, major, grades, job history and standardized test scores, according to American Banker.

Upstart's statistical model favors certain degrees - like nursing and computer science - that generally come along with low odds of long-term unemployment, the media outlet reported. A person's GPA is a reliable way of predicting how likely an individual is to pay back their loan, said former Google executive Dave Girouard. While the company reviews these academic qualifications, it also scrutinizes the factors that other lenders would.

"We also look at all the traditional variables, from income to debt to credit scores," Girouard told the news source, emphasizing that Upstart requires applicants to have a minimum FICO of 640. "It's really kind of a superset of what other lenders look at."

Opportunities for investors
Once this information is compiled, borrowers can potentially obtain funds from investors, who are paid back by receiving a portion of the young adult's income for a predefined period, according to The New York Times. This time is generally 10 years, but increases to 15 years for borrowers who make less than $30,000 a year.

To ensure borrowers are satisfied, Upstart caps the payback at five times the loan amount and limits available credit to 7 percent of future earnings, Girouard told the media outlet. The P2P lender also contains a provision designed to protect investors from borrowers who want to skip out on making their payments - without suffering from financial inability to do so - that converts the investment into a loan with a 15 percent annual interest rate.

"People might be paying more than they would on their fixed-rate loan," he told the news source. Thus far, borrowers have been willing to take the chance of paying back more than they initially borrowed, as this would mean they succeeded.

Potential market disruption
Currently, Upstart holds a modest share of the market, as American Banker reported on July 8 that the P2P lender's loan origination totaled more than $3 million in the previous two months. Analysts have made optimistic predictions about the company's innovative underwriting methods, saying they could prove effective. However, banks may encounter challenges if they seek to incorporate such an approach. G. Michael Flores, the chief executive of consulting firm Bretton Woods, may have summed it up best.

"Banks are still stuck with their traditional underwriting models," said Flores, who is an expert in researching alternative finance, according to the news source. "Some of that is inertia … but the other part is regulatory. To make an unsecured loan to someone with a thin credit file is just asking for regulators' criticism."