Buying a house is often a trial for the self-employed—even for those with very high incomes. With the lending process built around people who have traditional, W-2 jobs, free agents generally need to submit reams of paperwork to prove their income. The process can take months--if the entrepreneurs don’t get worn down and give up or get rejected first.
That is closing many people out home ownership. Currently, 40% of the U.S. working population earns a living through contingent jobs, according to data from the U.S. Government Accountability Office. Among them, 16.2 percent are either self-employed business owners or contractors.
Michael Slavin is one of a few players in the mortgage industry who is looking to change that. He is founder and CEO of Privlo, a 22-employee Pasadena, Calif., company that provides loans to small business owners and entrepreneurs, as well as other borrowers who "don't fit the conventional lending mold."
There are plenty of interested customers. Since it launched in 2010, Privlo has received $450 million worth of loan applications and has $70 million worth of active loans in the pipeline, says Slavin. The average borrower’s FICO score is 709, and the average borrower’s debt to income ratio is 41%, he says.
Privlo currently operates in 11 states: California, Colorado, Idaho, Illinois, Maryland, Minnesota, New Mexico, Tennessee, Texas, Virginia and Washington. “We decided to go after some of the larger states first,” says Slavin.
But he plans to expand. Privlo has raised $360 million. That includes $350 million in debt financing from institutional investors who provide the money for Privlo to lend and $10 million in equity financing from Spark Capital and QED Investors.
As you might expect, there are tradeoffs to borrowing from Privlo. Currently, it charges higher rates than some customers could potentially get from a bank. Interest rates for its borrowers range from 5.25% to 9.25%, and down payments start at 20%. The current average mortgage rate for a 30-year, fixed rate loan is 4.16%.
Slavin says the higher rates reflect the additional risk Privlo assumes when making its loans. “There is an implicit government guarantee around traditional mortgages,” says Slavin. “For ours, there isn’t.”
Privlo is not the only option for self-employed borrowers to get a mortgage. Some successfully borrow from a traditional lender. And there are a few other players targeting the self-employed. Impaq Mortgage Co., based in Irvine, Calif., also offers home mortgages aimed at the self-employed and is licensed in most states. QKMortgage.com in Los Angeles also offers a "self-employed mortgage loan" aimed at small business owners. However, it only makes the loans for investment properties that are not owner-occupied.
Slavin was working at a private equity firm on deals involving real estate when he noticed that the needs of small-business owners and entrepreneurs were being ignored in the mortgage market—and started toying with the idea of filling the need. He had a particular interest in real estate because his family owns investment properties in Idaho, where he grew up.
“I was building out these condo units,” he recalls. “We would get potential buyers who would come to the door—and needed to prequalify for a loan. I started noticing this interesting pattern of people who worked in fashion or Hollywood. They had significant savings--sometimes millions of dollars--and significant FICO scores, yet they couldn’t get a loan.” The remainin option, he found, was turning to hard-money lenders, who charge high interest rates.
Slavin got curious about why these affluent and potentially ideal borrowers could not get a bank to loan them money and realized traditional banks rely on a system of vetting borrowers that wasn’t equipped to measure the true creditworthiness of self-employed borrowers.
Suspecting he was onto something, he purchased some data from CoreLogic, a provider of financial data, on real estate transactions. Using that information, he estimated there was a $350 billion market in the U.S. for loans catering to the types of potential home owners he saw getting turned away.
By coming up with an algorithm that measured such borrowers’ true ability to pay back—instead of just rejecting them outright—he reasoned, he could serve their needs without the risk of making a lot of bad loans.
Working with former data scientists from Capital One, Privlo soon came up with its own algorithms to evaluate entrepreneurial loan applicants’ creditworthiness. It semi-automated the process of looking at their bank statements, tax returns , debt to income ratio, FICO score and patterns in using trade credit, to make the process more efficient. “We still have an underwriter,” he adds. Privlo also looks at business owners’ patterns in using trade credit.
The algorithm also allows Privlo to evaluate borrowers who have had a history of good credit but experienced a credit-busting event beyond their control. For instance, someone who suffered a bankruptcy because of medical expenses but had steady pension income might qualify.
One obstacle that has kept banks from lending to nontraditional borrowers is it requires more human labor to do so--and hiring people is costly. Some banks outsource mortgage loan processing to business process outsourcing firms--an automated approach that works best with W-2 employees who don't have multiple sources of income.
With technology improving by the day, Slavin has found it is becoming easier to evaluate borrowers who don't have cookie-cutter finances in an efficient way that is allowing Privlo to scale. “Technology is really is turning the tide,” he says. If he and some of the other players in this space succeed in a big way, it could mean that self-employed borrowers are no longer treated like second-class citizens in the mortgage market.
