Can Fintech Mortgage Lenders Fill Credit Gaps Left by Traditional Mortgage Lenders?

Fintech lenders have burst onto the scene, disrupting traditional lending in the residential mortgage market. But can fintech mortgage lenders fill credit gaps left by traditional mortgage lenders when the mortgage market faces unanticipated and temporary demand pressure?

Assistant Professor of Finance Yu Shan and two coauthors — Linda Allen, the William F. Aldinger Chaired Professor in the Bert W. Wasserman Department of Economics and Finance at Baruch College, and Yao Shen, an assistant professor in the same department — examine this question in the context of natural disasters, which leave a wake of destruction and thereby create a surge in demand in the local residential mortgage market.

Fintech mortgage lenders have moved away from the traditional business model that involves in-person communications, use of traditional data (e.g., job, FICO score and monthly income) and manual data input and management, all of which introduce pain points such as inaccurate credit scoring, inefficient document management and costly prolonged loan processes. Instead, they use end-to-end online mortgage application platforms and centralized underwriting and processing. Fully automated algorithms integrating machine learning and artificial intelligence help process credit information more efficiently than traditional lenders can.

To compare how fintech and traditional lenders respond to the surge in credit demand for reconstruction of damaged and destroyed property after natural disasters, the researchers analyzed loan-level mortgage application and approval data for the years 2010 to 2017 from the Home Mortgage Disclosure Act database and loan-level mortgage performance data from Fannie Mae and Freddie Mae.

The results, forthcoming in the Journal of Financial and Quantitative Analysis, showed that both fintech and traditional bank lenders increased their credit supply after natural disasters. But fintech lenders were more responsive, without charging higher interest rates as a convenience premium. Fintech lenders also expanded their credit supply more in areas dominated by banks dependent upon on-balance sheet lending and physical branch networks and relaxed underwriting standards more in such markets, in contrast to traditional banks. Nevertheless, fintech lenders did not experience higher delinquency rates than traditional loans.

“We provide evidence of the importance of incorporating tech-driven financial institutions in the credit supply dynamics of the local household finance market,” says Shan. “Regulators should create a corresponding regulatory environment that encourages the adoption of fintech loans as an alternative to traditional mortgage borrowing.”

As traditional bank lenders increasingly integrate financial technologies into their businesses, he hopes to look into additional questions. “How do the dynamics of this competitive landscape impact the effect of technology on local mortgage markets?” Shan asks. “This can be addressed by future research.”

Allen, L., Shan, Y., and Shen, Y. “Do FinTech Mortgage Lenders Fill the Credit Gap? Evidence from Natural Disasters.” Forthcoming in Journal of Financial and Quantitative Analysis.