Proposed regulations are shaking up the short-term lending industry. Instead of selling borrowers payday and auto title loan products, many lenders are now in the business of installment loans. Reports show that over the last 20 years, this sector of the lending field has experienced major growth. In fact, the installment loan industry is thriving in the face of a subprime job market.
The Installment Loan Industry Flourishes When People Struggle to Find Well-Paying Jobs
Pew Charitable Trusts reports that state and federal regulations have caused many of the largest payday loan lenders to offer installment loans. Pew says that this shift has been widespread across the country with auto title or payday loan lenders issuing installment loans in 26 of the 39 states in which they operate. The shift could also be because these lenders are seeing a greater need due to a dearth of well-paying jobs.
Installment loans serve consumers whose borrowing options are limited. According to a publication released by the Consumer Financial Protection Bureau, or CFPB, in a free market made up of rational consumers, the availability of credit lets people time their spending based on their needs and wants instead of by their incomes. Access to credit, regardless of cost, gives consumers more choices.
Installment Loans Were Not Included in Regulatory Oversight
In 2006, the federal government enacted laws that banned lenders from selling loans with annual percentage rates higher than 36 percent to members of the military. However, the law left installment loans out of the ban.
People have been able to borrow money through installment loans for decades. These loans are different from payday loans and cash advances when it comes to their repayment terms. While payday loans are due in just a few weeks, installment loans are repaid over an extended time. If people repay their loans in full and on time, then the borrowed funds often work in their favor. Problems arise when a borrower renews his or her loan repeatedly. When this happens, the loan transitions from a responsible lending option to one with sky-high annual interest rates. In fact, these rates can rise to more than 200 percent.
Some consumer advocates are urging the CFPB to address the industry’s interest rates. While this isn’t possible since interest rate caps are currently in the hands of the states, the agency has recently proposed rules that would require lenders to make sure that borrowers earn enough to repay them. The agency has also proposed limiting the number of loans that borrowers can take out successively. In addition, if the CFPB’s proposals go into effect, a lender would be required to notify a borrower of a payment before withdrawing it automatically from his or her bank account on the due date.
People Need Access to Small-Dollar Loans
It is possible for banks to fill the need for small-dollar loans. To do so, they could implement underwriting standards that are basic and clear. However, banks have hesitated to take this step because changing the current underwriting methods would increase their administrative costs. Nick Bourke, the director of the small-dollar loans sector for Pew Charitable Trusts, said, “Installment loans at 400 percent APR are still harmful even with more underwriting. Strong CFPB rules are badly needed, but the proposals focus on the process of originating loans rather than making sure those loans are safe and cost less.”
Who Turns to Installment Loans?
Reports show that at least 25 percent of American households do not have financial accounts through a traditional bank or have less access to one than they should. In addition, about 40 percent of those who have limited access to traditional banks acquire credit through small-dollar loans, pawnshops or rent-to-own companies.
The Center for Financial Services Innovation completed a study based on consumers who turn to short-term loan lenders for additional credit. It found that these borrowers are often from larger households, are frequently located in the country’s southern states and have below-average incomes.
What Does the Thriving Installment Loan Industry Say About the Country’s Economy?
While the country’s economic reports have been looking a little rosy lately, the thriving installment loan industry hints at underlying problems. According to the New York Times, recent data shows that 3.5 million Americans were able to pull themselves out of poverty last year. However, since the installment loan industry is prospering, perhaps people aren’t doing as well as the report claims. To read more about the thriving installment loan industry, visit the Personal Money Store.