Apr 21, 2014

Loan Purpose Research: Home Improvement Loans

Online Lending is known primarily as a way for borrowers to refinance existing credit card or other debt. Most press coverage describes this as the common use case, and many investors, especially those using analytical filters, restrict their investments to listings with this stated purpose. However, if believers in this way of lending/borrowing/investing are to see growth as large as expected borrowers will need to be able to use it for a variety of purposes. This transition is similar to what we have seen with credit cards. Credit cards started primarily as a tool for dining out and traveling – limited to larger purchases – and have morphed into the preferred payment method for many transactions (including my coffee this morning for $1.99). Online Lending needs to evolve to support a wider array of purposes. For this blog post, we’d like to explore the 2nd largest defined purpose for Prosper loans: Home Improvement. This loan purpose has always been particularly interesting to us, because it is already a sizeable portion of Prosper loans since 2011: ~8% of loans for a total of $56MM.

Below, we show the distribution of the top 10 Listing Categories:

Traditionally, homeowners requiring financing to make improvements/additions to their homes borrow against the equity of their home with either a Home Equity Loan or a Home Equity Line of Credit (HELOC), the HELOC being more pervasive. HELOCs were normally the easiest and cheapest option for borrowers. However, after the recent crash in home prices and the subsequent adjustment in the credit markets, many traditional lenders have been hesitant to lend against a residential property. It is more difficult now for a borrower to get this kind of financing, and therefore, alternatives are necessary.

The average size of outstanding HELOC balances as of 2013 was ~$30K. This is much larger than the ~$10K average size of a home improvement loan on Prosper. Prosper’s product could make more sense to borrowers interested in smaller projects. Also, a standard HELOC is time consuming to open and may have substantial fees (including annual fees, minimum balance fees, cancellation fees, and possibly prepayment penalties). Additionally, the interest rates are generally floating, which means that the monthly payment is not stable.

One question that comes to mind for home improvement loans is whether borrowers making improvements to their homes are actual home owners. We know from previous analyses on LendingClub that, in more recent vintages, having a mortgage is an indication of better performance. Looking at the distribution between borrowers seeking a loan for home improvement and for other purposes, ~70% of borrowers seeking home improvement loans own their homes.

When we review the default rate of 2012 loans, we see that homeowners perform better than non-owners (as mentioned above). We also see that home improvement loans perform better than the non-home improvement loans:

Now, we compare Home Improvement loans to the Debt Consolidation/Credit Card Loans (removing all of the other, smaller categories). We see that Home Improvement loans are basically the same for non-homeowners, but somewhat better for homeowners.

This is slightly different from what we saw in our loan purpose analysis on LendingClub, but in both cases, home improvement loans perform similarly or better than the overall.

It is important to note that a borrower’s intended use for the loan is not validated upon application, nor is it verified post funding, so this is merely a suggestion as to how the loans will be used. However, based on this finding, depending on your portfolio goals, amount of capital to invest, and other factors, home improvement loans perform similarly to debt consolidation and even better if the borrower is a confirmed home owner. This is great news overall for Online Lending as it provides a good alternative to the current housing loan options, and it expands the overall industry.

Angela Ceresnie
  • http://www.lendingmemo.com/ Simon Cunningham

    This is great. You guys are rockstars.

    • VAGuyWithNewName

      It is good info, but what I was hoping for was more of a critique of the 83%. For example, what do banks expect their roll rate to be on unsecured loans? And, how much does the effectiveness/ineffectiveness of the collection of delinquent accounts play into this? Could LC do a better job on collections and reduce the roll rate?

      • aceresnie

        Thank you for the comment. With regard to your collections question, we are actually in the process of analyzing and writing a post related to recovery rates on LC accounts that have charged off. It should be interesting.

        In terms of bank roll rates on unsecured loans, that information is tough to benchmark against as most banks don’t do much installment loan, unsecured lending (most lending to consumers is in the form of credit cards or revolving debt). My guess is that 83% is pretty standard.
        Thanks again,
        Angela

        • VAGuyWithNewName

          That’s great, but as a LC investor, I would be more concerned with the aggressiveness of the collection process for accounts that have not yet been charged off than those that have. Many times, someone who has already gone 120+ days past due is in such financial trouble that they no longer feel like they have the luxury of being concerned about their credit rating. They have given up and have more pressing issues (like food on the table). Someone 30 to 60 days late can be turned around more easily.