The established state of the credit and debt industry
Think about the traditional model of access to credit: when you buy a home, you visit one or more banks, provide the same information over and over again, and then pore over the terms trying to identify the best offer. When you buy a new car the dealer is sure to offer you a proprietary financing product, or send you to a “preferred” lender. Even the credit card in your wallet was likely sold to you on a visit to a branch or through a piece of direct mail advertising.
In other words, credit today is typically sold on the lender’s terms, not bought on the borrower’s terms.
The advent of robo-advice for investments
This is more or less how the asset management industry worked for decades, until Jack Bogle founded Vanguard and launched the first passively-managed, low-cost index fund. You could visit the local branch of Wells Fargo or Merrill Lynch and a broker would flip through the newspaper recommending whichever fund had performed the best in the last month or quarter, as long as it paid him a high enough sales commission. It was great business for the brokers to be in, and it was terrible for retail investors.
That industry model is in retreat, after the launch of a flurry of robo-advising firms which create customized, low-cost portfolios based on a user’s tolerance for risk, investing time horizon, and other factors. Without the need for a human salesforce, and therefore the need to generate fat commissions on every transaction, robo-advisors lower costs and, over time, are likely to improve the returns realized by retail investors.
Pioneering robo-advice for liabilities
The next disruption the finance industry will have to face is the widespread adoption of robo-advisors for liabilities. Just as Vanguard made low-cost investment options available to retail investors, companies like Credit Sesame are at the vanguard of the opportunity to help customers optimize their liabilities and make widely available options which are currently only accessible to the wealthy.
Robo-advice for liabilities has an even more ripe opportunity to disrupt the current configuration of the finance industry than the one we currently see in asset management. While robo-advisors for asset management are necessarily forward-looking (lower costs and higher or more stable returns in the future), robo-advice for liabilities can produce immediate benefits (lower costs and better terms now).
A consumer who is able to borrow $250,000 on a 30-year mortgage and pay 3.5% APR instead of 4% will save over $25,000 in interest over the life of the loan. Refinancing high-interest credit card debt into low-interest personal loans can produce both lower monthly payments and lower interest charges. Educating consumers about the full range of credit products available to them is another valuable service robo-advisors will provide. What are the chances your local bank really has the best rates on home loans, or that your car dealer really has negotiated the most favorable terms for car loans?
Today we can already see platforms like Lending Tree source loan terms from a range of nationwide banks and credit unions in order to find and serve up the lowest rates based on standardized information like credit scores and household income. As you’d expect, customers can achieve real savings when competition is widened from local or regional to national competitors.
The future of the credit and debt industry is robo-advisors
The future of credit isn’t in direct mail advertisements or loans of convenience, or even in online loan marketplaces like Lending Tree or crowd-funded platforms like Prosper or Lending Club. The next step is robo-advisors who tailor credit solutions to clients based on the entirety of their financial profiles.
A simple example: Is a customer whose credit report shows a maxed out credit card each month a good credit risk? Maybe, maybe not. A customer who pays off his balance each month and then makes additional charges might be an extremely low credit risk — a person with cash flow and high expenses who may not be in debt at all. On the other hand, a customer who only pays the minimum each month might be struggling to pay even that. That’s information a simple FICO® score doesn’t capture, but which will be trivial for the next generation of robo-advisors to evaluate and tailor solutions for.
In this field the application of big data will be decisive. A robo-advisor working on behalf of borrowers can educate them about the effect of their liabilities on their credit score, net worth, and access to credit based on millions of data points tracking the actual experiences of other users.
If a particular credit card balance or collection on a customer’s credit report is weighing down her consumer credit score, a robo-advisor can suggest ways to address the issue and explain the benefits. For instance, using big data, the robo-advisor can predict that a higher credit score might unlock more generous terms on the customer’s other accounts.
In many ways this disruption will be profound. Forcing banks and other traditional lenders to compete against creditors offering tailored products based on much more detailed information will present an uncomfortable choice. Banks could lower the interest rates they charge without the help of the risk models robo-advisors have at their disposal, or they can cannibalize their existing lending models and launch similar tailored lending solutions, as they have attempted to do (under pressure from the Department of Labor) in the retail investing space.
However, out of this disruption exciting new opportunities will emerge for firms nimble enough to seize them.
Adrian Nazari is a pioneer in liabilities management and the founder and CEO of Credit Sesame, a fast-growing financial wellness company that empowers consumers to improve their financial health. Prior to Credit Sesame, he was founder & CEO of Financial Crossing & Financial Circuit, developing liability solutions for banks. Adrian holds a BSEE, and an MBA from Stanford GSB, where he was a Sloan Fellow.
