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Alternative lenders in the U.S. are failing to detect borrowers who are "stacking" loans and it's making it harder for other lenders to spot the practice, according to sources quoted by Reuters.
Stacking refers to a scenario in which borrowers take out multiple loans in a short time period, often using the new loan to fund repayments on older loans. It's a widely known practice among small businesses, in part because they struggle to get funding from traditional lenders.
In 2015, only 45% of US businesses with £70,000 ($100,000) to £700,000 ($1 million) in annual revenue received all financing requested from large banks. That statistic drops to 37% for merchants with less than £70,000 ($100,000). Some lenders allow stacking, but many consider it a prohibitive risk because it can increase the chances that the borrower will default.
There are a number of reasons why the alternative lending industry makes detecting loan stacking difficult.
- The speed of originating loans. It can take 30 days for lenders' credit checks to show up on a credit report. But alternative lenders' expedited application and underwriting processes mean they can issue loans in just hours, compared to traditional lenders whose processes can take weeks. This means borrowers can get loans from multiple online lenders before their credit report reflects their true status.
- Alternative lenders use "soft" checks. Soft checks give an overview of a borrower's credit history, while "hard" checks are applications for credit, and therefore more thorough. Traditional lenders mostly use hard checks, which register on a borrower's credit report — unlike soft checks. Alternative lenders' credit scoring algorithms often combine soft checks with other information like bank statements and tax returns, which they say gives them enough information to make a decision. But it also means they may miss existing loans held by the borrower. And by not performing hard checks, online lenders make their own loans harder to detect for other lenders.
- They don't report to credit bureaus. A "significant number" of alternative lenders don't report to credit bureaus, according to Experian. There is no requirement for lenders to do so, but it means borrowers can have multiple loans from different online lenders, none of which show up on their credit records. In comparison, most major banks report to the three major US credit bureaus (Experian, TransUnion, and Equifax).
- Loan stackers may target alternative lenders. It's possible that borrowers who want to stack loans believe that it will be easier to get a loan from alternative lenders and actively seek them out after rejection from banks. That would amplify all of the previously mentioned issues.
Some alternative lenders are making efforts to tackle stacking — Prosper and LoanDeck have built algorithms designed to detect and prevent it. But overcoming this issue will likely require an industry-wide initiative.
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