Why Upstart Thinks It’s Cracked the Code on Young People

Big data is about to upend the traditional loan market.

student loans.
Instead of relying first on credit history, Upstart uses big data to crunch information that twentysomethings can actually provide: college, major, and grades.

Photo by Creatas/Thinkstock

When it comes to getting a loan, post-collegiate twentysomethings are seen as high-risk borrowers. They tend to lack the data points that most lenders look at to assess the chance of default, such as years of credit history and work experience. They’re often denied credit or hit with high interest rates, just because no one knows how to size them up.

All of that could change if a loan product being launched this week by alternative lending platform Upstart takes off in the mainstream market. Upstart, a financial services startup best known for its use of income share agreements—or investing in people—thinks it’s cracked the code on quantifying risk in young people. And it’s prepared to make loans of up to $25,000 on that bet.

Upstart announced on Wednesday that it is moving beyond income share agreements to offer traditional fixed-rate loans on its platform. The loans will be for three years with rates starting below 7 percent APR, and can be procured in as little as a week. There are also no fees attached to early repayment. None of that sounds particularly novel—and it isn’t. What makes these loans different from all others is their underwriting process.

When looking at young people, “most lenders would say, ‘Sorry, we don’t know much about you, we’re either going to reject you or charge you a high interest rate,’ ” Upstart co-founder and CEO Dave Girouard explains. “We basically said, ‘We can do better than that.’ ”

To keep that promise, Upstart is making use of an income-prediction algorithm it has honed for the past two years. Instead of relying first on credit history, this model uses big data to crunch information that twentysomethings can actually provide: college, major, grades, standardized test scores, and so on. “We’ve essentially created a product that gives you credit, if you will, for what you’ve accomplished to date,” Girouard says. “Because that provides some signal as to your employability and your responsibility.”

The new product is at once a boon and a curse for young people. On the one hand, it’s great that credit-worthy young people will have better access to fair rates and not all get lumped together. On the other hand, isn’t it a little scary to know that your high school grades have the potential to definitively affect your credit rates?

The specter of big data already looms over academics, and this will only make it loom larger. “I guess the fact that more benefits accrue to those who have proven themselves academically might seem unfair,” Girouard says, “but it’s hard to deny that it’s a merit-based system, which is actually pretty rare.”

The meritocracy critique can also be made of Upstart’s previous focus: income share agreements. These contracts allow individuals to sell “stock”—a share of future earnings—in themselves to investors, and earning potential is the name of the game. People with well-decorated resumes are more likely to get lucrative careers projections, and secure large sums of funding in exchange for a slim percentage of their future income. Each income share recipient was a big bet with big dreams and, for investors, the chance of a big payoff.

In some sense, then, this new product is a funny about-face for Upstart. With the more traditional loan, earning potential is less of a factor than earning stability. Academic success still matters, but you don’t need a high-paid gig at Google to get a good rate. Instead, nurses and teachers would be among the best performers because people in those professions are rarely unemployed. “We care about the statistical likelihood of unemployment, because that’s what typically causes someone to default on a loan,” Girouard says. “So whether you get a 5 percent raise or a 6 percent raise doesn’t matter to us so much, but what’s the likelihood that you’ll be unemployed for an extended period of time?” If you’re not trying to be the next Mark Zuckerberg, this new loan is a lot less sexy and a lot more practical.

Along with launching the APR loans, Upstart is also eliminating the 10-year contract option from its income share agreements: From now on, people raising money through these arrangements will only have to give up a percentage of their income for five years. It seems like another dose of realism for the company, which has spent the past two years fending off allegations that income shares are tantamount to indentured servitude. Shortening the length of the contract may help with that.

The bottom line, Girouard argues, is that the lending industry has gotten its youngest borrowers all wrong. “There was a Fed study that said, statistically, people in their 20s default on credit cards at a lower rate than others, which is counterintuitive to most people,” he said. “If there’s any keen insight that is leading to us doing this, it’s that the public perception that young people are risky borrowers is not true. That’s not lost on lenders, but they can’t distinguish between the irresponsible young borrower and the responsible one, so they sort of put them all in the same bucket. We have data that will help understand that.”

So if you went to a good college and got good grades, Upstart might offer you a deal. But if your transcript isn’t looking too hot come graduation time, there’s always the broader market.