How alternative data can help BNPL lenders with risk evaluation

Buy Now, Pay Later gained ground in recent years as an alternative form of credit for online retail purchases. However, amidst the continuing popularity of BNPL loans, late fees are becoming more common. Nearly 11% of users were charged at least one late fee in 2021, up from 8% in 2020, according to a Consumer Financial Protection Bureau report.

Additionally, new filings in a LendingTree survey also show that missed payments are on the rise at BNPL firms, with nearly 42% of BNPL consumers having made a late payment on their loan.

The advertising of BNPL loans can make them appear to be a zero-risk credit option, but these statistics indicate that many unqualified borrowers are overextending themselves by taking on this additional debt.

“Late and missed payment policies vary between lenders and the BNPL loan structure. Several BNPL firms offer automated debit payments from checking accounts which could lead to overdrafts or non-sufficient funds fees. In this way, BNPL offerings may help consumers purchase goods and services without incurring credit card debt or having to pay interest, but may still lead to negative financial outcomes if payments are not made,” said Joel Rickman, Senior Vice President of Verification Services at Equifax.

An analysis by Equifax shows that BNPL customers tend to have lower credit scores, incomes, and assets, and they are more likely to be debt-laden than an average consumer. Especially risky are customers who use credit cards or other forms of credit to pay their BNPL loans, effectively stacking one form of debt onto another.

Compared to credit cards, BNPL is a fairly new space – risk models may vary between lenders as the space gains more traction. They’re not all interest-free, their payment schedules can differ, and they lack some of the protections that come with credit cards. 

All things considered, regulatory bodies are starting to take notice of the growing number of BNPL users and examining consumer indebtedness and other BNPL-related issues with more scrutiny.

The CFPB opened an inquiry into BNPL late last year, signaling the likelihood of increased regulatory actions. Growing competition and new regulations likely taking shape may pose additional challenges for BNPL firms going forward.

But with so many consumers missing payments and a surge in late fees, what does the BNPL space need to implement in order to improve decision-making and risk evaluation?

In the current climate of inflation, rising interest rates, and overall economic uncertainty, BNPL lenders can deter the risk of late payments or loan defaulting by implementing alternative data in the decision-making process, according to Rickman.

Although BNPL lenders continue to revamp customer experience, this may be occurring with little to no verification of historical or current customer data. This leads to the risk of delinquent loans that may never be paid back. As this area becomes more defined, alternative sources of data could help BNPL lenders to make more informed decisions going forward.

Not hinging entirely on traditional credit reporting databases, alternative data is the new-age approach to financial information used by financial service providers to make better lending decisions. 

Unlike conventional data such as credit scores, bank statements, debt ratios, or mortgage payments, alternative data includes but is not limited to rental payments, telecommunications and utility records, digital wallets, mobile payment apps, e-commerce websites, social media, and open banking information.

Alternative data APIs bundle information from multiple data sources and other statistics from the digital footprint of the borrower. Aggregating, organizing, and analyzing various data points in a particular order can bring broader insights and provide a more holistic view into the creditworthiness of the borrower and the risk associated with lending to them.

Using alternative data for BNPL loan underwriting, layered with traditional credit file data, can further simplify and automate the risk assessment process – depending on a lender’s decision-making model.

Additionally, by requesting information verification from consumer credit reporting agencies, lenders can get near real-time employment and/or income information verifications, which are consumer reports governed by the Fair Credit Reporting Act (FCRA). Equifax is one such credit bureau that provides insights using alternate data sources for commercial and government verifiers through its The Work Number service.

Under the FCRA, any verifier requesting employment and/or income information must undergo a thorough credentialing process and have a legally required, permissible purpose for accessing consumer data in alignment with consumer consent.

Lenders will need to address and overcome a variety of challenges concerning both their customer base and repayment risks while continuing to provide real-time loan approvals built into their existing shopping flows in order to sustain the business model. This is where automated data verification technology can help lenders determine consumers’ loan affordability and repayment capacity while helping consumers avoid debt trap cycles.

Moreover, with digital fraud on the rise, validation of data from multiple alternate sources can help lenders mitigate fraud by keeping tabs on discrepancies that could result in possible fraud.

“Leveraging alternative data sets for loan decision-making can benefit both consumers and lenders," said Rickman. "By seamlessly integrating instant income and employment data into their decision-making process, lenders will have better visibility into consumers' financial capacity to lend more responsibly -- without negatively impacting the BNPL business model.”