Imagine the following scenario. Two people approach you asking for a loan. They are similar in nearly every way – income, employment, credit scores, and even the amount they are requesting. However, there is one difference. One of these individuals has borrowed money from you before. What does this extra piece of information say about him? Does it make you more or less likely to lend him the amount he is requesting?
This scenario is not just hypothetical. It happens thousands of times per month on the major Online Lending origination networks. Last month, over 10% of loans originated on Prosper were to borrowers who had previously been given a Prosper loan. On one hand, a lender might consider repeat borrowing to be a sign of risk. A similar pattern does exist with inquiries, as detailed in a previous post. On the other hand, a lender might take previous borrowing history as a sign of reliability. If you’ve lent to someone before, you may be more comfortable lending to him again than to a complete stranger.
To analyze this question in more depth, we examined a population of Prosper loans originated over a 1-year period between mid-2011 and mid-2012. At that point in history, Prosper seemingly had a larger proportion of prior borrowers than they do today. Perhaps today’s lower proportion reflects Prosper’s high rate of growth with many first-time borrowers now joining the platform.
Let’s examine how these loans performed. As we can see from the graph below, prior loan history was associated with a lower rate of delinquency. Furthermore, borrowers who had 2 or more previous loans were even lower risk than those with just 1 previous loan.
Let’s go 1 step further. Instead of simply looking at the existence of prior borrowing history, we can also examine the quality of someone’s prior borrowing history. The graph below breaks out previous borrowers who were 1 day past due even once on a prior loan. Unsurprisingly, this is associated with far worse performance.
A major factor in the performance we see above comes from Prosper’s own front-line underwriting criteria. As you may know, not every applicant is approved by Prosper to be listed on its platform. In fact, most applications are declined, and prior history – if applicable – plays a role. Borrowers who have charged off on a prior loan with Prosper are automatically declined for all future loans. Borrowers who have been at least 30 days past due on a prior loan but without charging off are automatically declined for a period of between 6 and 12 months depending on their credit score. Due to Prosper’s initial screen, prior borrowers who are successfully approved to be listed on the platform for a new loan are likely to be of high credit quality. When assessed along with other factors, prior performance may be a useful component of a successful investment strategy.
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