KOÇ UNIVERSITY

QMBU 420/520
TERM PROJECT TOPIC PROPOSAL
Gopichand ATHUKURI
Ali Kemal AYDINLIOĞLU
Robert HENZEL
Ömer SARI
The topic of our project is going to be loan default prediction analysis. The aim of the project
is to assess the customers that are likely to default on their mortgage loans and reduce the
adverse selection problem particularly in our business model which is explained below.

Loan Default Prediction for fully automated Mortgage Crowd Investment

The business problem that we target is the existence of risky borrowers who promote moral
hazard. Our goal is to minimize their negative impact on financial accounts. For this end, we
aim to deliver an automated platform which precisely predicts mortgage loan default
probabilities based on an online questionnaire. This concept is going to be applied for
mortgage loan crowd investment, where we provide a platform to mediate between mortgage
loan takers and a crowd of (private) investors, where our business model is commission and
high credibility for selection.

Workflow
Using our web service, potential lenders and borrowers apply to our mortgage loan pool. The
applicants get accepted or rejected based on the online questionnaire that we specifically
provide. This questionnaire involves basic variables such as age, gender, marriage status and
also variables like credit history, education, applicant income and so on… If the applicant is
accepted he has access to the listed loans that are available.

Through our mediating service, people are enabled to get mortgages from individual lenders
(investors) rather than institutions. This promotes a direct P2P scheme of borrowing where
people deal with other non-bank people. Having enabled an investment opportunity for
lenders, we get a predetermined share of the interest as the service charge.

Value for the Borrower

We create value for the borrower such that he can get credit without a bank involved.
Customers that banks refer to as risky and decide not to lend can potentially find resource
through our platform. This doesn’t mean that we collect junk borrowers, we just happen to
have our own methods to overcome adverse selection that might differ from banks in the
sense that private investors decide to lend or not taking their own risk. Nonetheless, we have
our loan default prediction model, which is the core of this project that helps the battle
against the adverse selection problem.

Value for Us
The value for our side is that we claim a portion of the interest rate of the loans and receive
other commissions. Most importantly, through the use of our prediction model, we have few
operational costs which fosters the profitability.

Value created for Investors

Unlike banks we will be connecting the borrowers to investors directly. Our selection of
borrowers is based on the automated process which only accepts those with the lowest
probability for defaulting the loan. Rather than being having to trust who the bank will
choose and whether there will be a problem in terms of adverse selection, investors might
trust us more as our selection criterions and borrowers pool will be way transparent. Being an
investor is less risky in our business model. In case of a default, loan is secured so risk of
total loss for investors is relatively small. If the lender goes bankrupt, we take care of the
mortgage to payout.
Risks for loan taker
Borrowers undertake greater risk by taking a huge mortgage loan. In the case of a default
they might end up with impayable debts. However, this is not a risk that is specific to our
business model. Any mortgage loan deal comes with the same risk.

Risks for Us
Our business model crucially depends on the algorithm which classifies borrowers with the
lowest probability of default. This algorithm should be as mistake-free as possible. Also,
accuracy and efficiency should be consistent. Even a little mistake would add unwanted
borrowers to the pool until we can fix it. If we cannot ensure consistent efficiency, platform’s
reputation would rapidly go down. In such case, number of the late loan payments might
exceed reasonable levels. This would create great risk for us.

Risk for the Investor

The potential risk for the investor is the probability of the borrower to default which we try to
minimize with our prediction model. Another risk for the investor is the trust that he puts on
our company regarding the selection of responsible borrowers that are presented to the
investors. Nevertheless, it is our objective to minimize the problematic transactions to
preserve our model’s reliability.

Data Source
For the business problem which is the problem of adverse selection, we decided to use
external data sources that are generated for similar loan default prediction purposes. With
this, we found a dataset from Lending club. Lending Club opened in 2007 with one simple
mission: create a more efficient, transparent and customer-friendly alternative to the
traditional banking system that offers creditworthy borrowers lower interest rates and
investors better returns. We will use lending club real data from 1/1/2014 to 31/3/2014 which
is more than 100,000 records (rows). We have two files one is for accepted loans and the
other one is for rejected loans. We will combine both the files to make complete dataset.

REFERENCE

http://web.archive.org/web/20140706042617/https://www.lendingclub.com/info/download-
data.action