For would-be borrowers with little credit history, getting a loan can be a nightmare. But one important group of applicants are young, well educated, and entrepreneurial—and would probably be favorable credit risks. Dave Girouard, CEO of the online peer-to-peer lending platform Upstart, believes access to capital is vital to young people’s careers. That’s one reason he left his job as president of Google Enterprise, which brings Google Apps to schools and businesses, to launch Upstart in April 2012 with partners Paul Gu and Anna Mongyat (another Google refugee). Techonomy asked Girouard to respond to questions about how lending platforms like Upstart can help investors and borrowers alike.
Do you specifically target younger borrowers, and if so why?
We serve borrowers of all ages, as long as they are at least 18 years old. But for sure we have particular skills and the ability to serve “thin file” borrowers—those without much history of credit.
The decision was a product of three observations. First, access to capital on fair terms is critical to young people; money is a fundamental building block of a career. Second, people without significant work or credit history are screwed by the consumer credit market. They’re presumed to be risky just for lack of proof otherwise. And third, there’s a ton of data available about individuals that lenders don’t ask about that is highly predictive of a person’s ability to repay a loan such as where they went to school, what they studied, and how they performed academically. The idea of looking at education-related data to predict creditworthiness owes itself to the Google hiring model—it’s the same data we used to make hiring decisions, so why not use it to make credit decisions? By understanding the person’s employability and earning potential, we can identify “future prime” borrowers before other lending platforms can.
Explain how Upstart’s peer-to-peer lending and borrowing component works.
We’ve created a platform that brings together high-quality borrowers and investors who can choose to invest in those loans. It’s a win-win in that borrowers get lower interest rates and investors can get attractive yield, relative to other investment opportunities.
Investors can actually browse through loans and invest any amount, starting at $100, in any loan. Alternatively, with auto-invest, an investor can simply create a filter that describes the type of loans he or she wants to invest in, and the amount of dollars per loan, and the investments can be made automatically by the system, with a particularly weekly or monthly budget. We service the loan and redistribute the repayments back to investors, making it super easy to invest on the platform and generate great returns.
What kind of information about the borrowers do you provide to lenders?
Although the loans are anonymous, the investor can see a lot of information about the borrower—credit score, monthly income, existing debt obligations, schools attended, test scores, and more. In addition to all the information you’d see on a more traditional lending website, you get insight into the borrower’s education, which is critical to understanding his or her employability.
Why are only accredited investors allowed to invest, and can you briefly explain how someone becomes an accredited investor?
Accredited investor is a definition created by the SEC. For individuals, you have to either have $1 million in assets, or earn at least $200,000 for each of the last 3 years ($300K for a household). It’s a self-reported concept, rather than something you apply for with the SEC.
The only path to allowing other retail investors to invest on Upstart would be to register the security with the SEC. There’s a tremendous amount of cost, complexity, and risk in that path, and it’s not something that makes sense for us as a business right now. Concepts like the JOBS Act may impact this in the future, although the current incarnation of that legislation is focused on equity investments in emerging businesses.
Why did you choose to distribute the risk to investors using a peer-to-peer model instead of originating the loans and collecting the returns?
We believe that creating a marketplace where we charge minimal fees to build and support the platform can have the most impact over time. Online lending is powerful when it eliminates the spread by directly connecting investors and borrowers. As a platform, we have the proper incentive to reduce costs and get borrowers the best possible rates. And because we forfeit the origination fee to investors on any loan that defaults (something no other lending platform does), our interests are aligned with platform investors.
In terms of short-term profitability, it would probably make sense on our balance sheet to be the lender ourselves, but that’s ultimately not as disruptive and valuable over time.
Do you ask borrowers how they intend to use their loans? If not, do you compile information about how disbursed loans have been used?
Yes. About 60 percent of borrowers are using the loan to pay off credit cards. Eight to ten percent are using the loan to either take a coding course or pay off a private student loan. The rest are split between relocation, a major purchase, or expanding a business.
What is the average size of an Upstart loan, and what is the average borrower age?
The average loan is between $14,000 and $15,000. Our average borrower is about 28 years old.
What are average interest rates for borrowers and returns for lenders?
Interest rates can range from about 6 percent to 18 percent, with an average of 11 percent. Returns for lenders range from 6.2-12 percent depending on the loan grade. The average return is 10 percent.
Have you considered using social media and a borrower’s social graph as criteria in determining credit-worthiness?
We’re a data-driven company, so we’re not into making leaps of faith about whether signals from the social graph may or may not indicate creditworthiness. Does the fact that your Facebook friend has a high FICO score suggest that you’d be a good borrower as well? I have no idea. So until somebody can show us something conclusive, we’ll stick to variables and methodologies we know to be predictive. [Girouard says he’s heard of the social micro-lending platform Lenddo, which uses social media to calculate credit-worthiness, but in developing countries only. He says he does not know enough to comment on its methods.]
With many recent graduates carrying significant student-loan debt, how do you feel about potentially increasing their debt burden—in many cases at significantly higher interest rates?
That’s not what we’re doing. The majority of Upstart borrowers are using proceeds to pay off credit cards. On average, they are reducing their interest rate by 600 basis points—that’s a gigantic improvement in terms of cost of credit. Others are paying off high-interest private student loans, so reducing their monthly payments. An installment loan doesn’t just save you money over credit cards; it also results in a better FICO score. And that decreases the cost of the mortgage you might want in later years.
The debt-to-income ratio of our borrowers is significantly lower than on either Lending Club or Prosper, and we’re very proud of this fact.