Credit Analysis: Number of Open Trade Lines

Both Prosper and Lending Club show us the number of open and current trade lines (credit accounts) our potential borrower has open at any given time.  This is an often misunderstood variable though so let's dig into some details.

Here is what one of the credit listing sections looks like on a Lending Club loan available for purchase today: (see Open Credit Lines and Total Credit Lines)

LC Credit Line Section of Loan ListingNote here that the total credit lines they have had in their entire credit history is 30 and open credit lines (lines that are active now) is 16.

Fewer is Better Because they have less debt/credit.......or is it?

One of  the things we learn from open trade lines is how many times before our borrower has been granted credit from other sources.  Even the most risk seeking of investors, and not just those of us who are risk averse, are of the likely line of thinking that they do not want to be the first to grant credit to someone. No one that I know wants to be the first to be lending or granting credit to someone, especially when that credit is unsecured.

Secondly, someone with no credit will have no credit score and credit score is a factor in the platform's loan grading and interest rate they pay as well as the most common of all filtering variables all of us potential investors use.

So it's clear we do not want, and probably cannot get, an investment in a p2p loan where we are extending the borrower their first access to credit. So does this mean that fewer trade lines is better?

Some would think that fewer trade lines is in fact better. After all, if someone has low personal leverage (not alot of debt they are currently paying on) then that means they are more likely to be able to pay our loan back, right? There is some truth to this as too much credit is not a good thing.

That being said, one of the institutional investor focused blogs in P2P lending,  Orchard  has a nice analysis on this subject and they believe that 2-4 trade lines is the range where defaults increase thereby making loans to borrowers with this range of open lines a higher risk. Go check them out. It's solid analysis.  Too few lines could mean that our borrowers don't have a well developed or predictable credit file  or maybe they have not yet developed the habits of a good credit payer by having numerous bills to pay on time. Any of which could be a higher risk. This is something we have to balance against the idea of low versus high personal leverage.  We can measure how well they are managing their personal leverage with Debt to Income (DTI) ratios.

So then maybe More is Better if they are creditworthy?

Now what happens when someone has very many credit lines? The good of this is that they have been proven to be creditworthy numerous times over time. Also, we see what their pay history looks like through their credit score and their current and recent delinquencies thanks to the loan listing so we can see if they are managing their existing debt loads favorably or not.

The bad of many trade lines is

1) how many lines is too many?  This is really a judgement call and is something that cannot be considered in a vacuum. We need to consider this and DTI and pay history and credit score all together.

2) high personal leverage means they are living closer to the edge of defaulting on multiple of their bills including our loan

Default rates per the Orchard platform analysis, indicate that above 5 trade lines the default rate is nearly the same for all additional numbers of trade lines measured and over 30 trade lines indicates an increase in net return and interest rate earned, mostly due to the impact of the number of  trade lines on credit score and the rate our borrower has to pay as a result. If FICO thinks they have too many trade lines then their score drops a little and the lower credit grade means a higher interest rate charged by Prosper or LC to borrow our money.  In other words, more trade lines is not a higher risk by the numbers, yet our returns are higher with default rates the same as a lower number of trade lines when they have more trade lines.

While this research indicates that more is indeed better, it is still a question of managing risk as to what number of trade lines and personal leverage is an area where we are comfortable when making our investments in p2p loans.  I look at trade lines with a combination of more is better plus a look at DTI to see how they are being managed currently and how the payment on the loan may affect DTI in the short and long run for our borrower.

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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