Installment Loans Gain Favor Over High Interest Short-term Counterparts
A recent Center for Financial Services Innovation and Core Innovation Capital report completed to assess the country’s financially underserved residents found that installment loans are gaining favor over their higher interest short-term counterparts. This research report offers the nation’s lenders a glimpse of the amount that financially underserved people spend on interest and fees, helping these institutions develop better products.
Installment Loans are Becoming More Popular than Short-Term Loans with Higher Interest Rates
According to the research report, financially underserved Americans spent $141 billion in interest and fees in 2015. Colleen Poynton, Core’s Vice President, said, “These numbers affirm our view that everyday Americans are struggling financially with a majority of American adults relying on high-cost products. The fact that spending on fees continues to grow at a high rate shows a clear need for tech-enabled entrants to deliver low-cost solutions at scale.”
The organizations complete their annual report to measure the market and determine ways to improve the fiscal health of the country’s financially underserved consumers. 3 BL Media reports that the assessment includes at least 67 million adults who do not have access to bank accounts as well as those who choose to use alternative financial services. Along with this, the study also measures marketplace revenue produced by people who are underserved because of their credit scores or due to their low-to-moderate incomes.
Not only are borrowers beginning to apply for installment loans for bad credit in larger numbers, but many payday lenders are also shifting their business practices away from lump sum loans to installment loans. According to the CreditUnionTimes, they are making this change to outrace regulators.
What Are the Advantages of Installment Loans for Bad Credit?
Installment loans benefit borrowers because instead of requiring an individual to repay the balance of a loan in one lump sum, lenders are permitting people to repay the amount in installments. Audrey Choi, the Head of Global Sustainable Finance at Morgan Stanley, said, “Demand continues to increase for more innovative solutions that help low-income Americans improve their financial security.”
Those who take out installment loans online can budget more easily since the payment amount will be the same every month. In addition, borrowers can gain access to the funds quickly. In fact, they should have their money in less than two weeks. Installment loans also prepare borrowers to work with traditional financial institutions since money borrowed through them will need to be repaid in a similar way.
Coming to the Aid of the Financially Underserved
If the country’s regulators decrease loan expenses, then this may tempt traditional financial institutions to become the lenders of bad credit installment loans. Because they are diversified organizations with the ability to cover their overhead expenses by offering other products, banks and credit unions have a sizable competitive advantage over auto title and payday loan lenders.
Traditional financial institutions would likely be able to offer loans at rates that are six to eight times lower than short-term lenders. If they were to enter this area of the market, they could decrease the number of underserved Americans that are out there, increasing their own lending numbers. This would also extend the number of customers who would be making regular checking account deposits while giving more people access to low cost loans.
Statistics show that traditional financial institutions could make a profit by providing small loans that come with double-digit annual percentage rates. This would be the case even if they were offering them at six to eight times lower than payday lenders. However, underwriting requirements have kept these institutions out of the market. It has done so because the intricacy of the underwriting process requires a great deal of staff time and documentation, potentially eliminating profits.
If lawmakers are actually interested in helping the financially underserved, they need to find a way to streamline lending so that it thoroughly vets a borrower without miring a lender down in paperwork.
Bad Credit Installment Loans Can Be as Harmful as Payday Loans
When short-term loan lenders offer bad credit installment loans, they can be as harmful to borrowers as payday loans. Pew Charitable Trusts reports that bad credit installment loans become harmful when the payment amount is unaffordable. If borrowers are unable to manage the payment amount, they may resort to rolling over the loan, or they may become overdrawn.
Payday loan lenders who issue installment loans online like to set up payment amounts that are more than 5 percent of a borrower’s income. Statistics from several states show that these loans are between 7 percent and 12 percent of the average borrower’s monthly income. According to studies, this amount is too high.
In Colorado, regulation has made installment loans affordable because they must feature smaller payment amounts and reasonable pricing. Industry experts report that lenders should be required to complete some underwriting to establish a borrower’s ability to repay the money that they borrow.
Front-Loaded Fees Cause Problems with Installment Loans
As short-term lenders have moved into offering installment loans, they kept some elements in place such as the origination fees. These fees are harmful to consumers because they increase the cost of the loan. When the charges are billed at the start of the loan, it penalizes borrowers who pay their loan back early.
Lenders charge these fees because it increases their profits. This also tempts lenders to encourage people to roll their loans over since they charge them a fee to do so. Small-dollar borrowers are more likely to extend these loans since they usually have low-to-moderate incomes, decreasing their ability to pay back the money that they borrow timely.
Lenders of installment loans for bad credit could make the loans more affordable by spreading the fees and interest charges out over the loan’s life instead of front-loading them. This could be something that regulators decide to require. If they do, then this would align the interests of the borrowers and the lenders. Financial institutions that lend out these types of loans would remain profitable even as they keep loans affordable for borrowers. People who borrow money would also have more incentive to repay the funds early.
Borrowers See the Value of Installment Loans Online Over Payday Loans
Installment loans online are gaining favor over their higher interest short-term counterparts because of the stretched out repayment terms. However, installment loan lenders may find themselves under the same watchdog scrutiny that payday loan lenders face if they fail to make them affordable for borrowers. While these types of loans are currently flying under the radar of regulators, consumer misery would likely change this. To read more about the value of installment loans, visit the Personal Money Store.