Behavioural Underwriting and How It Works
Following our recent guide on what is underwriting, we want to dig a little deeper to look at behavioural underwriting and the role it plays for lenders and how they decide whether an applicant will be approved or declined for a loan product.
What is behaviour underwriting?
Whilst underwriting refers to the steps taken to assess whether a person is eligible for a loan, credit card or mortgage, ‘behavioural underwriting’ focuses on the applicant’s user and demographic behaviour when making the decision.
A provider will make their approval or decline decision based on the characteristics that the applicant has and whether similar customers have repaid or defaulted. The behavioural factors that lenders look at include:
Age: Do particularly age groups have lower default rates than others?
Gender: Do some genders repay better than others? Do females pay on time more often than men or visa-versa?
Location: Are some areas of the UK better at paying on time than others? A recent study by This is Money showed that areas of Northern Ireland, Wales and West Midlands have higher level of debts than other parts of the UK.
Residential status: Is lending to those that live at home or with friends riskier than granting a loan to a tenant or homeowner?
Employment: Does being on benefits, part-time or fully employed mean you will be more or less likely to repay your loan.
Most lenders will usually work these aspects of underwriting into the initial criteria that you see on a website or their basic application. Companies say that applicants need to be over 18 or in employment, as a way to narrow down their ideal candidate.
More complex factors
Some lenders are real technology companies and can use more sophisticated metrics as a way of understanding their customer’s behaviour and eligibility for a loan:
Time on the site: Is it possible that users that spend more time on the site, researching and understanding the product will be more reliable than someone who just clicks and applies instantly?
How much they ask to borrow: There are myths that some lenders track the loan calculators on their websites and customers that try to borrow the maximum amount as their first port of call are deemed ‘riskier’ than those who pick a specific amount.
Whether they read the terms and conditions: Using time on the site, eye tracking technology or heat maps, some tech companies can tell how long someone reads the terms and conditions and loan agreement for. Logically, a customer that understands all the terms of their loan will be far more responsible than one who does not.
Repeat visitors: Is someone who visits the website for the first time going to be more reliable than someone who visits it for the 5th time? Is it better that they have reviewed the website and come back or does coming back several times suggest that they are making so many applications that they do not even remember who they are applying with?
How behavioural underwriting is used in the score card
Most sophisticated loan providers have a score card when it comes to underwriting. So when an applicant fills in their details, they will be given a score and whether it meets the grade, their loan will go to the next stage or even be funded. The lender can decide what number to set based on their risk or appetite to lend.
To give a basic example, if the maximum score is 100, an applicant may need to reach 70 points to be funded. If each factor is worth 10 points, Having an age with a good repayment rate might give you 7 or 8 points, living in an area with a high repayment rate might give you 8 to 9 points and being a homeowner might give you 10 points and so on.
Can you underwrite purely on behaviour?
Yes, but its not recommended and could be a violation of the governing body. Historically there have been lenders that funded payday loans purely on behaviour. For instance, they would receive an application and based on the fact that the borrower is female, aged 35, a homeowner and says she is employed, there is a 90% chance she will repay her loan on time (based on their statistics), they would fund the candidate’s loan in 15 minutes.
Well, this approach is all well and good for the 90% of customers that do repay, but what about the other 10% that have just been given a loan despite having lots of debt and CCJs in the background? These people were given loans irresponsibly and will now suffer more debt as a result. This approach and failing to do checks has led to several lenders receiving huge fines and having to refund customers, read more about it here.
A combination approach
In practice, the best underwriting approach is a combination of behavioural analysis and also the use of credit checking and proper affordability. By a lender paying a small fee to a credit reference agency like Equifax or Experian, they are able to see into a borrower’s credit history and review how well they have repaid other types of loans and whether they have any outstanding.
Furthermore, through the use of affordability checks, lenders can get an idea of how much the customer wishes to borrow and what they can afford to repay. These checks include confirming salaries via pay-slips and looking at the individual’s expenses by receiving a copy of their bank statement. The lender may decide to match the amount the customer wants, lower the amount or decline them altogether.
As per FCA regulation, all loan companies in the UK are required to carry out credit and affordability checks. However, the use of behavioural metrics can be extremely useful and with the right technology and analysis, can lead to very successful underwriting for the company and low default rates.