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More clearly understanding a consumer’s capacity to safely take on the incremental debt they are seeking is a challenge all lenders face every day when reviewing credit applications and managing existing customers. This is especially true in mortgage lending, where past approval practices placed many consumers into loan terms that they simply could not afford to sustain, driving the higher loss rates currently being experienced.
Traditionally, lending practices include the use of income-based measures, such as debt-to-income ratios, to gauge a consumer’s ability to handle incremental debt. Income information itself, however, has limitations in reflecting consumer capacity. Questions include the accuracy of the income field, the predictive implications of gross income relative to disposable income, and other sources of variation such as region and cost of living. What’s missing in today’s lending practice is the ability to answer effectively, with or without access to income information, “Who can safely manage additional debt?”
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