Understanding the “I” in Debt-to-Income
This is the second of a two-part series by Tom Oscherwitz, VP of Operations and Counsel, looking at evolving lender approaches to understanding personal income. A link to the first part of the series is here.
Income is undervalued by lenders. I know that statement sounds strange, so let me explain.
Compare what lenders know about a consumer’s debts versus what they know about a consumer’s income. Lenders and their information providers have spent decades scouring every nook and cranny to gather a full view of consumer credit history.
The United States has three nationwide credit bureaus, whose databases each reflect the industry’s mature knowledge of debt and credit repayment. Each bureau maintains files on over 200 million Americans, with over 10,000 companies furnishing them with data, and over a billion active trade lines.
Lenders can ping these databases to learn what loans consumers have, how much they owe, their repayment history, and as well as their current demand for credit. This information has proven incredibly valuable and supports a wide variety of use cases ranging from account acquisition to collections, account management, and even income estimation.
Has the lending industry similarly invested in understanding income?
The short answer is no.
It’s not that income is completely disregarded. Income is a staple feature in debt-to-income (DTI) as well as other ability-to-pay calculations. The DTI ratio, for example, calculates a consumer’s capacity to manage debt by dividing monthly debt payments by their monthly gross income.
To generate these calculations, mortgage lenders typically require home buyers to release their tax returns. Some lenders may ask for other proof of income such as pay stubs, W-2 forms, direct deposit or bank statements. There are also various companies that access payroll data or consumer bank accounts to assess current consumer income, albeit with some privacy concerns.
But, too often, a consumer’s income is either unknown or provided as a point-in-time snapshot. For a significant swath of Americans, lenders have no easy, low-friction way to get a good understanding of income, let alone more sophisticated assessments of income durability, the potential for increase or decrease, or other income features.
To use a baseball analogy, our understanding of income is in the second or third inning, while debt insights have reached the seventh-inning stretch. Imagine if all a credit bureau file told a lender today was a point-in-time snapshot of a consumer’s debt. That’s it. No payment history. No length of credit history. No discussion of amounts owed.
That’s where we are today with income, and that’s why Aire is so excited about our income journey.
At Aire, we strongly believe that income assessment is more than a numerical snapshot. It’s a story of the work people do. It’s about jobs.
Except for the very highest wage earners, almost all consumers’ income stems from their jobs. According to an analysis of IRS tax data by the Tax Foundation, consumers with salaries under 50k get 95% of their total income from their work. Consumers with salaries between 50k and 100k get 92% of their income from work. And consumers with salaries between 100k and 200k get 88% of their income from work.
By understanding job characteristics such as the location of work, size of employer, length of job experience, part-time or full-time work, and even stated income, lenders can draw powerful insights about the income a consumer makes today, comparable to what lenders get on the credit side of the consumer balance sheet. Just as we can look at trended data for credit, jobs can unlock income trends. Just as lenders can use credit reports to look at the consistency of repayment, job insights can point to issues like income stability or income trajectory. Isn’t it obvious that employees in a start-up face different income risks than school teachers or government workers? Isn’t it obvious that a seasoned plumber will make more than someone new to the trade?
Lenders can do so much more with income. It’s time to give income its due.