The dilemma in lending

The best credit performance comes from borrowers who don't need the money. It's an oxymoron, and yet true.

Beyond that, credit rank-orders by urgency: the greater the borrower's need, the worse the credit. Financial institutions and credit scores capture this with traditional bureau data and non-traditional data. It's why a hard inquiry, which signals need, lowers a FICO score.

That's rational, and it's grounded in historical data.

Where the rule breaks

As with everything else, not every situation is the same. Borrowers who need money now but have good income prospects can be excellent candidates for lending.

Think of a resident physician, a recent graduate starting a well-paying job, or someone in the middle of a career move. Their present looks like need. Their future looks like strong repayment capacity.

Traditional credit analysis, which looks at past behavior and current income, can miss this future potential. It's also harder to analyze: it requires predicting an individual's future income and expenses, which isn't easy.

The reward

Institutions that can reliably identify these borrowers and lend to them stand to gain a great deal:

1. They can price for the urgency, earning a premium that the borrower's eventual credit quality doesn't justify.
2. They earn loyalty. Lending to someone when others wouldn't creates a strong customer experience, especially if the lender follows up with positive actions (rate reductions, line increases, refinancing) as the customer makes financial progress.

Much of the best-performing specialty lending I've seen since, from student loan refinancing to professional-segment lending, is built on solving exactly this dilemma.