President Biden’s student loan forgiveness plan was widely anticipated by both consumers and lenders. The plan offers between $10,000 to $20,000 in relief on federal student loans to consumers with incomes under $125,000 ($250,000 for married couples) while extending student loan repayment forbearance through the end of 2022.
The White House estimates more than 40 million consumers could be eligible for at least $10,000 in forgiveness and roughly 20 million of these consumers will have their student loan debt completely wiped out. While many consumers had hoped for full forgiveness of federal student loan debt, this debt forgiveness still presents a broader financial opportunity for both consumers and lenders.
The mass student debt relief should help younger consumers from middle-to-lower economic backgrounds and produce significant improvements in their interest in and ability to manage new financial products.
For financial institutions, this announcement generates many questions centered around their financial inclusion strategies and whether they are prepared to service greater demand from an improving segment of young, near-prime consumers.
The most critical question for lenders is whether their financial inclusion strategy includes entry-level financial products for which these consumers could potentially qualify. The merits of offering certain financial offerings for which near-prime applicants can qualify provides opportunity to graduate these consumers into more revenue-generating products while consumers, in turn, can enjoy the loyalty benefits from financial institutions associated with early credit relationships.
Today, lenders tend to approach financial inclusion by focusing on identifying underrepresented consumers who meet their current lending criteria, a worthwhile effort which hinges on utilizing alternative data and largely avoids creating new financial products targeting a less-prime consumer segment than their current portfolio. The reality is that this kind of strategy heavily limits a lender’s ability to drive growth through financial inclusion, including the opportunity now presented by student loan forgiveness.
Why? Consumers who will benefit most from the president’s debt forgiveness plan are often still relatively new to financial services. Their management of student loan debt may have made them credit-visible, but their age and debt load has likely prevented them from amassing a broad set of credit relationships. The end result is a consumer segment with near-prime or slightly subprime credit scores that often underestimate their credit quality.
A consumer’s traditional credit profile will improve with this debt relief, but that will not happen immediately nor solve for the gaps in visibility that can hamper a lender’s evaluation of younger consumers in particular. Any organization with a financial inclusion strategy looking to capitalize on student loan forgiveness will be heavily constrained without the full picture of this consumer segment offered through alternative data.
Alternative data — from credit seeking to public records and rental data – gives financial institutions a more comprehensive look at a consumer’s overall financial picture. It includes insights into other areas of a person’s financial life, like whether they have a professional license which can help provide access to a steady income stream, own large assets like property or vehicles or have paid their rent on time for the last 24 months.
While the student loan forgiveness plan is a clear positive for consumers who qualify, the eventual end of loan forbearance presents a risk in 2023 of destabilizing some of these consumers. While consumers’ payments will be lower, there is a risk that some consumers will have confused the terms “forbearance” and “forgiveness,” leaving them unprepared to meet their financial obligations once repayment resumes.
Lenders should establish comprehensive education programs now to ensure consumer awareness that payments will be restarting soon while simultaneously strengthening portfolio monitoring to recognize early signs that some consumers may be struggling to meet repayment terms. When consumers pay off federal loans in a consistent and responsible way, financial institutions benefit in the long term from having built relationships with financially accountable consumers.
By preparing now with the right products to target this soon-to-be debt relieved group and using more insightful data to place applicants into those products, student loan forgiveness could become a major part of a lender’s portfolio growth story in 2022 and 2023.
Kevin King is vice president of credit risk at LexisNexis Risk Solutions.
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