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Are Convenience Check Loans Underwritten to Ability-to-Repay?

posted by Adam Levitin

In my previous post, I complained that convenience check loans weren't underwritten based on ability-to-repay.  That's not to say that there's no underwriting whatsoever.  But it's important to recognize that prescreening for direct mailing for convenience check loans is not the same as underwriting the loans based on ability-to-repay.  For example, Regional Management, on the companies that offers convenience check loans says in its 10-K that:

Each individual we solicit for a convenience check loan has been pre-screened through a major credit bureau or data aggregator against our underwriting criteria. In addition to screening each potential convenience check recipient’s credit score and bankruptcy history, we also use a proprietary model that assesses approximately 25 to 30 different attributes of potential recipients.

That's dandy, but a credit score is a retrospective measure of credit worthiness. It doesn't say anything about whether a borrower has current employment or income, and it doesn't generally capture material obligations like rent or health insurance.

However fancy the proprietary model and its secret blend of herbs and spices, it is a totally different process than what Regional Management Describes for the loans it makes through its branches:

For loans made through our branch network, we carefully evaluate each potential customer’s creditworthiness by examining the individual’s unencumbered income or debt-to-income credit ratio, length of current employment, duration of residence, and a credit report detailing the applicant’s credit history. Our loan approval process is based on the customer’s creditworthiness and ability to repay the loan, rather than the value of collateral pledged. Loan amounts are established based on underwriting standards designed to allow customers to affordably make their loan payments out of their discretionary income. Each of our branches is equipped to perform immediate employment and credit checks, and approve loan applications promptly while the customer waits. Our employees can verify the applicant’s employment and credit history through telephone checks with employers, other employment references, supporting documentation such as paychecks and earnings summaries, or a variety of third-party credit reporting agencies.

I will note, however, that the regulation implementing the CARD Act's ability-to-pay requirement (first enacted by the Fed, but then adopted by the CFPB), permits lenders to use proprietary models to determine ability-to-pay if the models are statistically valid.  Given that card applications are still just stated income applications, it would seem that some combination of credit scores plus models are being used to satisfy ability-to-pay for credit cards.  The CARD Act rulemaking only requires ability to make the minimum monthly payment (generally 1%-2% of the balance plus any finance charges, which means that ability-to-pay is a very low threshold for credit cards.  Still, I'd be curious if CFPB examiner teams have ever pressed to see the evidence of regarding the statistical validity of the underwriting models and just how predictive the models turn out to be.  

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