It came as no big surprise when a credit-worthiness study showed 67% of consumers in the so-called alternative-loan market fell in the subprime category, the riskiest of credit tiers.

Yet the study by credit bureau TransUnion indicates many of those alternative-loan consumers perform well when they transition to traditional financing, including auto loans.

Alternative loans often are taken out by consumers who need money fast or have no other avenues to secure a loan. Alternative financing typically is short-term and include pay-day, installment and rent-to-own loans.

That group of creditors can come with baggage, but often not enough to sink a ship, the study suggests.

Despite their relatively high risk from a traditional credit-scoring perspective, “those who maintain satisfactory payment status on alternative loans can in fact present acceptable risks on traditional credit products,” says Matt Komos, TransUnion’s vice president-research and consulting. That includes longer-term auto loans.

Alternative loans are one of the largest categories not reflected in traditional credit files. But credit bureaus now track them using improved technology and algorithms indicating loan-payback likelihood.

Accordingly, more and more lenders are warming up to using alternative-credit histories when deciding whether to approve a loan.  

“There’s a lot more information now that lets lenders build a full picture,” Komos tells WardsAuto. “This was the missing piece.

He adds, “As we build up more data and predictive models, more traditional lenders will accept alternative credit as a source.”

The study looked at five million people who took out alternative loans over years. Surprisingly, some of them who had shaky credit histories previously now rank as prime-plus, Komos says. “They built up their credit.”  

The study corroborates that many alternative-loan borrowers present greater risks on traditional loans. However, a material subset presents reasonable risks on traditional financing products, including auto loans.

It’s “a great financial inclusion story,” says Liz Pagel, co-author of the study and TransUnion’s vice president-financial services business unit.  

“The study identifies various metrics that can help lenders differentiate higher risk consumers from lower risk using alternative-loan data, and thereby extend credit where they may not have previously,” she says.

Consumers who have taken out alternative loans multiple times and paid them back have a significantly lower probability of delinquency on a traditional credit product.

For example, the study found lower delinquency rates (9%) with near-prime alternative-financing borrowers who had eight or more alternative loans over the course of seven years. “That’s an interesting study highlight,” Komos says.

By comparison, borrowers in the same risk tier had a 14% delinquency rate when they had one short-term loan and a 12% delinquency rate when they had two alternative loans.

The TransUnion research signals to the financing market that “lenders may benefit by conducting business with this subset of the population, a group they might otherwise not be targeting with credit offers,” Komos says.

He advises automotive lenders and the like to do their usual due diligence. “As with all credit data, it’s imperative to dive deeper and employ a thoughtful analytical approach when evaluating consumers with alternative loans.

“If done right, lenders can gain broader insights and hence a better ability to identify and quantify risks, which in turn allows them to grant credit more widely and with greater confidence. In that way, the whole market wins.”

sfinlay@wardsauto.com