At Earnest we have long hypothesized that there was a fundamental mismatch between banks and borrowers when it came to student loans. How could the old credit reporting metrics used by many lenders, such as FICO, apply to people in their 20s and early 30s given the increasingly high costs of education?
The short answer is: Traditional credit scoring doesn’t do a great job. New research from Earnest reveals how traditional credit scores are misaligned with young, career-track borrowers, and how this mismatch is potentially slowing down their ability to get out of debt faster.
Louis Beryl, Earnest CEO, presented the company’s research to the Bloomberg Markets Most Influential Summit in New York City in October 2015.
A Clearer Picture of Credit Scoring and Student Borrowers
According to Earnest’s anonymized data from nearly 14,000 loan applicants, those with the highest levels of student debt, associated with advanced degrees in medical or legal fields, had substantially lower credit scores than borrowers with medium-sized student debts.
At $100,000 of debt, the median FICO scores in Earnest’s applicant base hit a peak of 750, with a median income of $82,000. Those with advanced degrees in law and business, or other master’s degrees are likely to fall in this group.
At even higher levels of debt, the borrowing pool is mostly made up of those with medical, pharmacy, and dental degrees as well as law degrees. Incomes keep rising at higher debt levels, reaching a median income of $165,000 for those with up to $500,000 in debt.
Yet between $100,000 and $500,000 in student debt, FICO scores drop, decreasing to a median of 720 for those at the highest level of debt and income.
Data has also correlated higher debt with higher income, which means these high-debt young professionals should be some of the highest value lifetime clients for any financial institution they choose as their financial partner.
Note: The scatter plot above shows median incomes and median student debts for each degree type. For example, a medical doctor takes out a median of $180,000 in debt, though some in our applicant database had as much as $500,000 of debt.
Earnest Offers a Better Way to Measure Intangible Assets
What does this mean for borrowers and lenders alike? Traditional credit reporting just doesn’t do a good job measuring the intangible asset of education and earning potential. In our experience, these high-income, high-debt young professionals are generally very good borrowers despite their credit scores.
For lenders, it adds up to a missed opportunity. For borrowers, due to their lower credit scores, they’re less likely to find competitive rates on credit products that can help them pay off debt more quickly or move onto larger financial steps, like buying a home.
As politicians and policy makers continue to look for ways to tackle the $1.3 trillion student loan burden in the United States, we believe part of the solution is creating better alignment between lenders and student borrowers.
One way to do this is to evaluate applicants for more than just their credit score, particularly when high levels of student debt are involved — the degree, income and long term value of the education that resulted from it are a strong and valuable asset of the borrower.