When I was studying for my MBA, my favorite courses were in economics. On the first day of one class, the professor wandered in with a stack of newspapers. Each paper contained an article that he’d selected for the sole purpose of reading aloud and then demolishing its argument. The exercise wasn’t to convince us that journalists are stupid (really!). Instead, it was to show us the value in critical thinking, and the danger in taking the easy path in work and life.
I’m reminded of this daily. We underwrite consumer credit for home improvement contractors. You wouldn’t guess it, but there’s tremendous variety in consumer underwriting. While it may not be as glamorous as structuring multi-million dollar commercial deals, there’s an art, if you will, in consumer credit. For example, consider the following scenario:
- An individual application from a middle-age homeowner
- Excellent credit in the upper-700s with all payments made on time
- Very modest applicant income of $1,800 per month
- Monthly debt payments of $950 for the mortgage plus $125 for some credit cards.
We see deals like this every day, but they are the equivalents of winged unicorns. They’re make-believe! The characteristics of the deal don’t make sense when subjected to critical thinking. We have a responsible homeowner with a good history of repayment but a 60% (high) debt-to-income ratio. The disposable income (money left over for living expenses) is only $725. How does someone with this profile make ends meet and maintain a high-700s score?
A quick check of the credit report and there’s the tell-tale sign, the little “J” next to most of the debts indicating they’re joint debts. In “official” consumer lending parlance, we have ourselves a one-legger. The deal was submitted with only half the household income earners because it’s easier to do than to collect the other party’s details up front. Bucking the easy trend, we will ask the contractor whether there is more income or another applicant in the household in our decline notice.
We do common sense underwriting, which includes a healthy dose of critical thinking. Unfortunately, less than half of these one-leggers will come back to us. Rather than collect the information on the second applicant, the deal will be shifted over to a less rigorous lender because it’s easier. Those lenders typically charge for their services and have higher interest rates. So, instead of the borrower getting a good deal and the contractor getting the full margin on the sale, they both settle for less.
Most of us heard the story of the road less traveled as kids and maybe periodically hear it as adults. The easier way is always attractive, seductive even. But easier doesn’t always mean better, and a little critical thinking can help determine when a few minutes of additional effort is the road less traveled.