Future of Fintech: Income Verification Challenges

March 17, 2021

Before approving a loan application, a lender must verify a consumer’s income to ensure that they can afford the monthly payments. Traditionally, the financial institution would require the potential borrower to submit pay stubs to substantiate their earnings. While asking for this information has been the standard operating procedure for years, there are some limitations and challenges associated with relying on the practice for income verifications.

What’s Happening Now?

Even though reviewing pay stubs to verify income is the long-standing norm, it’s not necessarily the best way. Here are three reasons a lending institution should consider alternative methods:

  • Using pay stubs is inconvenient and time-consuming.
  • Paystub data isn’t standardized.
  • Paystub information shows a limited view of consumer income.

Let’s dig a little deeper into each of these reasons.

Pay Stubs are Inconvenient

The best financial transactions are completed accurately - and quickly. Relying on pay stubs to verify a consumer’s income can slow the process way down. That’s because the bank has to wait for the prospective borrower to get them from their employer and submit them to their loan officer for review. The lender may have to ask for the information multiple times, and the consumer could run into delays obtaining the stubs. It could drag out the lending decision, causing stress and frustration for all parties involved.

Pay Stub Data Lacks Standardization

Believe it or not, there are no federal regulations to govern pay stub distribution and required information. On top of that, nearly half of the country’s states lack pay stub-related laws or guidance. That means it’s often up to each employer to determine what data a stub includes - or doesn’t.  

As a result, bankers can’t assume that a consumer’s pay stubs will provide the information needed to make a lending decision. If the stubs don’t meet the financial institution’s requirements, the lender will need to find another way to verify the customer’s income. The inconsistent standards could make an already lengthy process even longer.

Pay Stub Information is Limited

Even if the bank receives a consumer’s pay stubs in a timely manner, and the stubs contain all of the required data, the lender is still getting incomplete income information. That’s because the statements only show the consumer’s income over a set period - usually a month or two. The financial institution receives no insight beyond that. And, while connecting to a customer’s bank account can provide a more extended income history, it’s limited by the account's age.

Plus, while the lender can calculate the potential lendee’s debt-to-income (DTI) ratio, they’re still missing a more valuable data point: the consumer’s adjusted gross income (AGI). The AGI is the prospective borrower’s net income and illustrates how much they can afford in monthly loan payments. When the bank makes a lending decision based on DTI and AGI combined, the institution is reasonably assured that the borrower will repay their obligation.

How ModernTax Can Help

ModernTax is a powerful application programming interface (API) that connects financial institutions directly to the Internal Revenue Service (IRS) database. With a few keystrokes (and the consumer’s permission), the bank can access 250+ pieces of tax information in roughly three minutes - including the prospective borrower’s AGI.

Lenders can feel good about using this tool. It’s fast, efficient, secure, and provides a robust set of data. Bankers won’t have to ask for (and chase down) pay stubs, or worry about getting the information required from the statements. Plus, they can make a better-informed lending decision. Borrowers will appreciate the simple process and timely response to their loan applications.

Final Thoughts

Banking institutions have relied on pay stubs for a long time. But, to remain competitive in the marketplace, satisfy consumers, and make sound lending decisions, bankers should consider a change. Technology gives lenders the ability to quickly and accurately assess borrower risk. ModernTax and other related APIs are leading the revolution.

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