Fintech & Culture Part 4: Lending
Modern banking began way back in Renaissance Italy in the 1400s CE. Some of the main functions of the original Italian banking institutions were to hold money, supply insurance, and conduct financing for individuals. In the centuries since then, not a lot has changed – banks have continued to fulfill these roles. In this post, which is the fourth in our series on Fintech and Culture, we’ll be focusing specifically on the lending arm of financial institutions and looking at how fintech has transformed lending over the past few decades.
A loan is something that is borrowed – usually an amount of money – that is expected to be repaid with interest. Interest refers to the extra money the borrower is expected to pay back to the giver on top of the original amount borrowed; that extra amount is agreed on when the loan is facilitated. When people or companies borrow money today, they’re generally borrowing it from an entity that has access to a lot of it, i.e. a financial institution like a bank.
These days most Americans have taken out a loan in at least one form. But contrary to what you might assume, loans and debt aren’t only for people or businesses strapped for cash. In fact, according to Debt.org, the wealthier you are, the more likely you are to have debt and in higher amounts.
Debt is accrued for a variety of common reasons like buying a house or a new car, paying for higher education, or covering unexpected emergency expenses. But there are many other reasons people may need or want to borrow money as well. Sometimes personal loans are taken out to help consolidate a variety of other debts a person or company has. Or a loan can help cover the costs of a large necessary purchase (like a house appliance) or to help with a remodel.
Businesses – especially SMEs – also take out loans for many different reasons, usually with the overarching goal of growing the business. Similar to personal loans, business loans help small to medium companies do things like purchase new equipment, buy or lease a property, hire more employees, or develop a new product.
Loans make things possible that wouldn’t be otherwise. They allow individuals to buy property, to go to college, to receive medical care, etc. They help companies get started or expand into a new market. But historically speaking, traditional loans are more beneficial in the long run for the institution lending the money than for the entity borrowing the money. Banks decide who they’re willing to loan money to and when; they decide how much collateral is necessary; they set the interest rate the borrower will pay on top of the principle; i.e. they hold all the power. This means that only certain people with certain credentials qualify for loans, which has resulted in years of inequitable financing and a huge percentage of people being blocked from the related benefits of financing. Also, interest rates on certain kinds of loans tend to be extremely high, which means that people or companies who do qualify remain in debt for a long time without much hope of achieving financial freedom.
Lending Alternatives through Fintech
In the first post of this series, we briefly explain how the goal of fintech (finance technology) is to create or build resources that assist people in accumulating and managing wealth. That goal is relevant for every person and company no matter what their income is or financial goals are. In our previous posts we discussed how fintech relates to applications, payments, and climate change, and in this post we move to consider how fintech has changed the landscape of lending.
We know now that fintech platforms make loans and financing available to more people through the use of technology that brings better data, analysis, and marketing to consumers. Fintech helps lenders make faster and more-informed decisions about who to finance. It makes accessing loans easier for consumers. It removes the old boundaries that prevented financing and often empowers underserved communities. Let’s look at some of the subcategories of fintech lending and how they are different from traditional lending:
In the past, applying for and getting a mortgage was a long and tedious process. It started with first getting pre-approved and pre-qualified through a traditional bank, which involved getting a full credit report from a reputable credit reporting agency, so that you knew how much money you qualified for. You had to physically gather a series of documents like identification verification, tax returns, pay stubs, bank statements, and more. Then you would actually apply for a mortgage which was a many-step ordeal. Only after all that could the loan be processed, underwritten, and you could close on the property you wished to purchase.
Getting a mortgage through a fintech company makes the whole process much faster and accessible to more people. Potential customers can shop around for the right loan opportunity much more easily through fintech apps. Fintech lenders can complete the entire loan process online at any time instead of requiring in-person meetings. They can offer lower interest rates. They may have less strict qualifications for applicants’ credit scores and debt-to-income ratios or down payment percentage. They approve less traditional applicants and situations. And it all happens days, if not weeks, faster than going the traditional route. How is this possible? Well fintech companies have significantly lower overhead costs than traditional financial institutions, so they don’t need to make as much money on the actual loans themselves.
Peer to Peer Lending
Another emerging idea from fintech is peer to peer lending (P2P), or marketplace lending. P2P lenders help individuals or companies to connect with an investor or other entity that will give them a loan directly through the P2P platform. Most fintech lenders utilize something called decentralized finance, or DeFi in their processes, which through blockchain technology omits the need for third party companies and traditional centralized institutions to participate in financial transactions. This makes accessing and obtaining a loan easier and faster, and interest rates can be more competitive.
Receiving a loan can be especially challenging for small businesses since traditional financial institutions think they’re too high-risk to approve. Fintech gives SMEs an opportunity to receive financing – and receive it much more quickly – when they wouldn’t have in the past. When applying for a business loan through a fintech platform, the applicant can easily connect their financial institutions and instantly transfer financial data over to the lender. Fintechs generally don’t require the same traditional credit score history or data that other banks do; through machine learning and AI, they can access other predictive information that would ultimately help the business get approved. The whole process can take minutes instead of months like previously.
Fintech Lending in Real Life
Although traditional banks are still managing and approving loans today, fintech lending companies are now edging them out. For example, Rocket Mortgage, a fintech lender which started in 2015 out of Quicken Loans, had become the United State’s largest mortgage lender by the end of 2017, and by 2021 they were the originators of over 1.2 million loans. They also have infiltrated pop culture in many ways since then. They’ve partnered with Amazon to make mortgage payments easier through their smart devices; they host elite sporting events and competitions; they sponsor professional sports leagues and the building of sports arenas; they’ve acquired and launched other related financial apps for consumers.
Today only two of the top 10 lenders in the country are traditional banks – all the others are either fintech companies or independent brokers. What this means is that alternative ways of applying for and receiving financing have fundamentally changed over the last decade, and people are fully on board. It seems like fintech lending is here to stay.
Fintech lending requires fast and reliable access to financial data in order for companies to make accurate decisions about loans. Pentadata is a technology platform that bridges the gap between financial institutions and fintech apps by safely accessing and porting consumer financial data. If you’re a developer in the fintech lending space and want to see how Pentadata’s financial APIs could benefit you, reach out today!