Before loaning money to a consumer, a bank needs to assess that consumer’s financial standing and risk. The banker will use a variety of tools to gather the necessary information, including a credit check. The problem is - a credit check provides an incomplete picture of the prospective borrower's overall financial health.
What’s Happening Now?
Credit checks have been widely used to assess consumer risk for years. Data from a credit report indicates how much debt a potential borrower has and reveals how responsibly they’ve handled that obligation over time. While the information is useful, it doesn’t give a financial institution enough insight to make a lending decision.
There are two main shortcomings of credit checks:
- They don’t include income information.
- They provide inconsistent data.
Let’s review each of these in turn.
Lack of Income Information
To fully assess a potential borrower’s ability to repay a loan, the bank needs to calculate their debt-to-income (DTI) ratio. A credit report only provides half of the information required to do the math. The report shows a list of the consumer’s credit accounts, when they were opened, how much is owed, and when payments were made. But it has no record of the customer’s income.
Even though a consumer’s credit report or credit score can shed some light on their financial situation, the data may not be completely reliable. That’s because there’s a lack of standardization across reporting agencies and credit scoring models. There are three credit bureaus - Experian, Equifax, and TransUnion. Each of them may receive different information - or no information at all - from a consumer’s creditors. Plus, several credit scoring models (including multiple FICO models) could produce scores that vary substantially based on the data used to calculate them.
This inconsistency could alter how a lending institution perceives a consumer’s level of risk. If a bank orders a credit report through a bureau that lacks accurate, negative data, the consumer may be approved for a loan they’re not qualified to receive. On the other hand, if a report contains a negative item that the consumer successfully petitioned for removal from a different bureau, they may unfairly be denied a loan.
How ModernTax Can Help
ModernTax is a sophisticated, new application programming interface (API) designed to simplify the consumer vetting process. The tool connects directly to the Internal Revenue Service (IRS) database and pulls more than 250 pieces of data in three minutes - including the customer’s income and adjusted gross income (AGI).
With this information, the bank can calculate the consumer’s DTI. Then, the AGI, or the net income, reveals what the consumer can truly afford. The best part? The financial institution doesn’t have to chase the consumer for pay stubs, tax returns, or other documents -- and the potential borrower doesn’t have to waste time trying to find them. Plus, since all of the insight comes straight from the IRS, the lender can rely on its accuracy and standardization from consumer to consumer.
Credit checks and credit scores are staples in the financial health assessment process - and they’re not going anywhere anytime soon. But, despite their usefulness, they don’t tell the whole story. Banks need other pieces of information, such as income, to make the right lending decision. APIs like ModernTax are paving the way for a more efficient, accurate, and consistent procedure that benefits both financial institutions and consumers.