Bloomberg Businessweek
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For more than 40 years, banks have counted on FICO scores to determine the credit worthiness of American consumers. Now a handful of entrepreneurs in California say it’s time for a smarter way to size up borrowers.
Los Angeles-based ZestCash Inc., along with San Francisco startups BillFloat Inc. and LendingClub Corp., are hiring computer programmers to write software that can better identify candidates for loans—including people with low credit scores. The companies, backed by venture money, also aim to provide lower fees and interest rates than banks.
“There hasn’t been a lot of innovation in the space for a while, and it’s time for that to happen,” said Rebecca Lynn, a partner at Menlo Park, California-based Morgenthaler Ventures, which is backing LendingClub. “We’re looking at companies that are doing new underwriting and using new underwriting methods.”
The idea is to use technology to root out potential fraud and give more finely tuned assessments than FICO, named for Fair Isaac Corp. Rather than just looking at black marks on a person’s credit score, new software can analyze how someone uses money on a daily basis, giving more insight into whether they will pay back the loan. Like other Internet companies, the new crop of lenders will keep operating costs down by delivering loan applications and services over the Web—instead of having to maintain physical branches.
FICO, founded in 1956, is used by 90 of the largest 100 U.S. financial institutions, according to its website. FICO takes into account a potential borrower’s debt outstanding, payment habits and length of credit history and provides a score that ranges from 300 to 850. The median last year was 711, and lenders vary on what they consider a good credit score.
People like Holly Dickerson are benefiting from newer approaches to lending. Dickerson, a youth counselor in St. Charles, Missouri, needed a loan last year to have her son’s braces removed, pay her dad back for some borrowed money and afford rent at two apartments following a divorce.
Her FICO score was too low to qualify for a loan from her local credit union, and she didn’t want to use a payday lender. With ZestCash, the 49-year-old was able to fill out an application online and was shortly approved for a $400 loan, due in installments over six months.
“When I went to the bank, they said I needed a credit rating of 600, and I was below that,” she said. “The installment program makes it so much easier to pay off the loan as opposed to having this big chunk.”
The startups are each going after a different piece of the lending market. ZestCash is taking on payday lenders by providing loans of $300 to $800 that can get repaid over three to eight months. BillFloat provides smaller loans—up to $225—to pay specific services, such as electricity or mobile-phone bills. LendingClub focuses on prime borrowers and offers up to $35,000 for loans that let customers consolidate debt, remodel their homes and pay medical expenses.
Douglas Merrill, Google Inc.’s former chief information officer and the founder of ZestCash, said FICO scores ignore much of the digital data that’s been created by online activity and transactions. He’s almost doubled his staff to 75 since July, hiring mostly mathematicians and programmers to come up with an algorithm that produces more reliable scores.
Merrill started ZestCash in 2009 with Shawn Budde, a former senior vice president at Capital One Financial Corp. By combining homegrown Web-crawling tools with underwriting expertise, ZestCash uses more than 1,000 variables to determine a score and issue loans that the company says are about half the price of payday loans. Customers typically use the money to pay rent, catch up on health bills and get their cars fixed.
