Traditionally, credit scores were the main tool that lenders used to determine loan risk. Lenders want to see that a borrower can responsibly manage debt and make on-time payments before extending credit. However, this creates a catch-22—if someone has never borrowed before, they can't prove their ability to make on-time payments.
Over-reliance on credit scores also makes it challenging for borrowers with economic challenges to rebuild credit. Second look financing is changing the game by giving those without credit history a “second chance” to gain access to credit.
Nearly 50 million Americans do not have a credit score or are considered "unscorable," meaning they have rarely borrowed money, while another 106 million U.S. consumers have credit scores at or below what’s considered “subprime”. This means millions of Americans can’t borrow money for purchases like a reliable car, home repairs, or other everyday needs. Second-look financing, which considers additional data outside of credit scores, provides more consumers with access to credit without increasing risk for lenders.
What is second-look financing?
Second-look financing offers potential borrowers a second chance at obtaining a loan based on a more holistic view of their finances. For lenders, it’s a prudent way to weave alternative data sources, such as cash flow information, into their lending strategies to supplement traditional credit data.
Consider a lender who pulls traditional credit data on a borrower during a loan application. The borrower has a thin credit file that’s around the margins of what’s approvable based on the lender’s underwriting strategy. The lender may “pend” the application for more information or outright decline based on its risk appetite.
If they decline the borrow without obtaining more information, the lender may be leaving a potential customer on the table. However, the lender didn’t know that despite their low credit score, this applicant has a steady income from a self-employment business that could have helped qualify them for this loan. The borrower wouldn’t get the financing they need and their credit score will be hit by the credit decline.
With second-look financing, the lender could prompt this applicant to link their primary bank account to get a more holistic look at their creditworthiness. By looking at cash flow data like their bank account balances, income (whether from salary, part-time, gig-economy work, or government benefits), transaction history, and other account activity, the lender would be able to verify the steady self-employment income. Using that new information, they might be able to turn a “no” into a “yes”.
Who benefits from second-look financing?
Second-look financing is a win-win scenario for both lenders and consumers. Consumers can access credit they may have previously been denied, often at lower interest rates. This can limit the impact of small emergencies, such as a car breaking down, by giving them financial flexibility.
It also allows folks who have struggled with poverty to build wealth by purchasing a home or finally buying a reliable car to get to work. Second-look financing also benefits millions of people known as credit invisibles, who have little to no credit history. However, the benefits extend beyond expanding credit access.
Lenders also have much to gain from second-look financing, including access to a wider customer base. Using cash-flow data like utility payments and non-W-2 income allows lenders to assess risk for a broader range of applicants, increasing loan approval rates. Other benefits include:
Reduced lending risk: According to the CFPB, using cash flow data in addition to credit scores is more likely to predict late payments—meaning using cash flow data doesn't just improve second-look financing; it also improves traditional lending decisions.
Improved customer loyalty: Offering second-look financing can enable lenders to build loyalty as customers are likely to have a more positive view of a lender willing to take a chance and help them build their credit.
Stronger loan terms: Lenders can also leverage second-look financing to improve loan offers (higher credit limits, lower rates, etc.) for already-approved applicants based on strong cash flow data, creating stronger customer satisfaction.
Expanded access to credit: Offering second-look financing could make it easier for lenders to expand access for all types of groups, including those that have historically faced barriers to getting affordable loans.
While second-look financing offers numerous benefits for both consumers and lenders, implementing it can be a challenge. That's where Plaid can help.
Cash flow data is going mainstream
Hear what 400 lending professionals and 2,000 borrowers have to say about the next era of lending
Plaid is your partner for second-look financing
Plaid offers several solutions to help lenders provide second-look financing and expand their customer base. Plaid Income, for example, allows lenders to link to consumers' bank accounts and view comprehensive identity, employer, and gross and net income data.
Consumers are willing to share this data. According to Business Insider, 81% of consumers say they are eager to share more financial data for a faster, easier loan approval process, and 60% of loan applicants say they would share bank account information if it meant obtaining lower interest rates. Plaid's focus on user experience means that financial institutions access more data and consumers have a better experience—resulting in a higher conversion rate.
A core challenge in second-look financing is accessing and understanding cash flow data. Many financial institutions do not have the tools to turn cash flow data into actionable insights about lending risk. Plaid's consumer reporting agency is filling that gap by improving the availability of cash flow data and increasing usability by cleaning data and providing actionable insights. Lenders can use this data to make smarter decisions while enhancing the user experience.
Second-look financing expands credit access
Traditional credit scores are a crucial piece of the lending decision process. However, relying on credit scores alone closes the door for many consumers. Take the example of an immigrant who has held the same job for five years, has never opened a credit card, and lives well within her means. While she may lack a credit score, with second-look financing, that hard-working consumer may be able to access credit to purchase a reliable car or cover much-needed dental work.
The world of lending is changing. Open banking provides lenders with access to more data while improving the user experience. Second-look underwriting is in turn expanding access to credit for millions of Americans while giving lenders access to a broader customer base.
At Plaid, we're excited to be a partner in creating a future where more people have access to the credit they need and lenders feel empowered to leverage cash flow data to make smarter risk decisions.
→ Learn more about how Plaid’s Consumer Reporting Agency (CRA) can help you gain greater credit risk insights from cash flow data.