Personal loan default prediction and impact analysis of debt-to-income ratio

Abstract

Loan defaults affect the financial sector, particularly impacting banks and lending institutions, resulting in a rise of non-performing assets and financial strain. To counteract this trend, traditional credit assessments use methods like credit scores and exploitation of socio-demographic composition of the customers. However, customers may possess numerous debt obligations that credit bureaus uncover, which can help to measure their repayment ability. This study proposed a comparative methodology that leverages five machine learning algorithms to predict personal loan defaults using debt-to-income ratio apart from the credit scoring models that prevail at banks. It analyzed the impact of debt payments on loan defaults and applied ensemble clustering to categorize customers’ risk levels based on their debt-to-income ratio. Experimental results indicated that ensemble clustering has enhanced the prediction power compared to conventional classification models to predict loan defaults.