For our December Pathways Fireside Chat, UMA hosted a conversation with Brendan Martin, Co-Director, Seed Commons/The Working World; Marie Peters, Colorado Main Street Lead, Colorado Lending Source; and moderator Nia Evans Director of Boston Ujima Project to discuss “Nontraditional Underwriting Standards.” 

Nontraditional underwriting standards create opportunities for lenders to provide the type of support their borrowers really need. For CDFIs, non-profit lenders, and similar funding institutions, this practice involves implementing underwriting measures that more closely align with investing in the underrepresented communities they serve. This is primarily accomplished through improving the accessibility of the loan to the borrower. Traditional underwriting places more burden on the borrower by demanding high interest rates, short term lengths, and collateral requirements, as well as requiring high credit scores and other traditional determinants of a borrower’s perceived riskiness. These methods often create barriers to assessing capital for small businesses, which are big job creators in our local communities, particularly for BIPOC-owners who face systemic racism and lending bias as they look for capital to start and grow their companies. 

Our December 2020 Fireside Chat featured two organizations, Seed Commons and Colorado Lending Source, and how they use nontraditional underwriting as alternative strategies to both vet and support borrowers in such a way that the barriers associated with traditional underwriting are greatly reduced or eliminated.

Strategy 1: Redefine Credit and Character in the Underwriting Process 

Credit history is often a mark of circumstance, not character. Borrowers may not have great credit due to family medical history or extenuating pre-existing events that do not reflect their ability to repay a lender. Rather than a starting point, our panelists said credit history is something they consider in the final steps of the underwriting process. Instead of having a hyperfocus on credit score as the primary determining factor, they suggest trying to understand the narrative behind credit reports with low scores to place these numbers into context.

Likewise, sources of support shown by mentorship and business relationships often provide a more robust image and likelihood of success of repayment. Understanding the entrepreneur and their networks gives lenders a clearer perspective on the social capital, experience, and resources that mitigate a lender’s risk. Borrowers may be taking advantage of accelerator programs, small business development centers, and/or other business services which build a stronger network of support. Character vetting gives prospective borrowers the opportunity to highlight their company’s culture and its impact on the community. 

Strategy 2: Lend from the Perspective of Investing

Considering historical wealth disparities by race, class, and gender, lenders requiring capital collateral from personal wealth is an extractive lending principle, as it places additional risk on communities that already face barriers to wealth management and creation — if they default on a loan, they risk losing equity they’ve built in their home, savings, car, etc. Instead, Brendan Martin of Seeds Commons, suggests that lenders consider only using assets purchased with funds from the current (or potential) loan as collateral. This inherently provides extra security for the borrower, and is more inclusive of underrepresented borrowers for whom failure through traditional collateral lending principles would mean losing wealth and assets. 

Using collateral acquired through loan funds allows lenders to underwrite the quality of the business plan instead. In this way, lenders can evaluate deals through the lens of an investor, which aligns the incentives of the borrower and lender. This process strengthens the relationship between borrower and lender, increasing communication and the ability for lenders to aid in the business planning process, thereby decreasing the chance for default. Further, lenders acting with an investor lens may be incentivized to think of ways to help businesses grow to become the top competitors among their industry peers either by engaging in big capital investments or long-term loans with low monthly payments. 

Strategy 3: Building a Team that Reenvisions Your Relationship with Your Borrowers is Key

Beyond the loan and business officers, the lending organization’s underwriting committee itself should also be diverse. Having lending experts on staff with strong business planning skills and experience with start-up/entrepreneurial ventures makes engaging in these strategies more fruitful for the borrowing businesses, and also more secure for the lender themselves.

But lenders should also consider taking steps to engage their external committees and partners in their transition to implementing these new strategies. For example, Colorado Lending Source provides tailored training to their underwriting committees ensuring they are in alignment with the lender’s values and underwriting standards — especially if they are traditional institutional partners who often might put too much weight on aspects like credit scores. “The goal is to be friendly, affordable capital,” said Marie Peters of Colorado Lending Source. 

Wrap Up Thoughts

While these strategies may be referred to as friendly and “nontraditional”, these standards are often more intensive than traditional methods. By incorporating a more well-rounded view of the borrower’s business plan and networks of support, these “nontraditional” strategies are often more thorough and informative compared to traditional lending standards, and their methods make them more useful to borrowers, too.