When Banks Won’t Lend – Bad Credit Borrowers and Payday Loans

When banks won’t lend, bad credit borrowers often turn to payday loans. When borrowing money from a bank, many factors are considered before a traditional financial institution will issue a loan. These factors include the borrower’s annual income, credit history and debt-to-income ratio. If a loan consumer fails the bank’s lending criteria, then the would-be borrower is likely to turn to alternate lenders. Some people reach out to their preferred credit card company while others turn to family members and friends. If a low credit score is the reason for the denial, then alternative borrowing options may be limited.

Bad Credit Borrowers Need Payday Loans When Banks Refuse to Lend

When banks refuse to lend to borrowers who have poor credit, a number of these people turn to the payday loan industry for help. For many, the modern-day economy has been a tough one. Wages have stalled while many expenses continue to rise. This has created a situation that makes emergency cash hard to acquire. For those with poor credit, payday loans may be the only option.

What Does it Mean to Have Bad Credit?

Investopedia states that poor credit is a description of a person’s credit history when that history indicates that the individual is a high credit risk to lenders. When a person’s credit score is low, this signals bad credit while a high credit score is a sign that someone has good credit. Creditors who lend money to a person with bad credit know that they are facing a greater risk that the person will be late on payments or outright default compared to when they lend to those with good credit.

A person’s credit history is made up of several factors. These include the total amount of debt that an individual owes, access to available credit and payment timeliness. Poor credit occurs when a person makes late payments to his or her creditors. In the United States, the Fair Isaac Corporation, or FICO, determines credit scores based on information collected by the three main credit bureaus, which are Experian, Equifax and TransUnion.

Why do Payday Loan Lenders Overlook Low Credit Scores?

Payday loan lenders have found a profitable niche. While some people continuously default on their credit and cause lenders to lose money, there are those who are working to rebuild a low credit score. In addition, because traditional financial institutions won’t typically lend to people with low credit scores, those who have one need access to lenders who will give them funds during a financial emergency.

Along with offering people the funds that they need, payday loan lenders make a tidy profit. According to a Center for Responsible Lending 2013 publication, consumers pay an estimated $3.4 billion in fees to payday loan lenders annually, so these lenders are certainly profiting.

A Genuine Demand for Small-Dollar Loans

A recent report published by the Consumer Financial Protection Bureau, or CFPB, states that the short-term loan industry “depends on people becoming stuck in these loans for the long term.” This is prompting the agency to propose regulations curbing it. However, instead of honing in on every type of payday loan, the CFPB is focusing on the loans that are causing customers the most harm. The agency believes that the most harmful loans are the ones that people roll over.

Richard Cordray, the head of the CFPB, said, “The agency is focused on cases where the subsequent loans are prompted by a single need for money. That is, the follow-on loans are taken out to pay off the same initial debt for the consumer.” Cordray admitted that borrowers who repay a payday loan after using it to take care of an urgent situation like a car repair are likely benefiting from small-dollar short-term loans. This shows that even the head of the CFPB knows that the country has a genuine need for short-term loan products and that the payday lending industry is satisfying that need. Traditional financial institutions could offer this service, but they don’t seem interested.

Why Aren’t Banks Stepping Up?

To date, banks have yet to set up programs or products for borrowers who have low credit scores. For traditional financial institutions, implementing these types of loan products may be more trouble than they’re worth. However, when banks won’t lend to bad credit borrowers, payday loans are one of the few options available to these individuals. To read more about the problem with banks failing to lend, visit the Personal Money Store.