Small Loans Industry Thriving, Despite Regulatory Assaults
The financial sector saw changes following the Great Recession; one such change was the shift to small loans. Borrowers are taking out small loans with bad credit at an ever-increasing rate. While this is good for the burgeoning industry, the sector’s growth is catching the eye of regulators like the Consumer Financial Protection Bureau or CFPB. Making sure that borrowers can repay loans and creating changes to term limits are just a few regulations that legislators have enacted against the sector, but the small loan industry is thriving, despite these regulatory assaults.
Regardless of Regulatory Action, the Small Loan Industry is Flourishing
The Banking Exchange reports that a small loan is usually for $500 to $10,000. In addition, people typically pay them back within 5 years or less. Often, borrowers with credit scores that range from 300 to 660 seek this type of financial product because they may not have access to revolving credit through credit cards or from other types of lenders. Small loans with bad credit are an easy and convenient way for people to gain access to the funds that they need.
Because the small loan industry has been a fraction of the traditional lending market, it has garnered little attention from regulatory agencies, but dramatic growth in recent years is bringing about change.
Small Loans Appeal to Consumers in Every Credit Tier
Most small dollar loans are approved for consumers who are considered non-prime borrowers. This means that they have credit scores that are on the low side. Basically, most of these loans go to people who have very bad to fair credit. However, borrowers with prime credit are starting to take out small loans too. Statistics show that since 2010, the number of prime consumers with small-dollar loans has increased by 8 percent. A prime credit score is from 661 to 850.
TransUnion studied loan trends over a five-year period. The credit reporting agency determined that 54 percent of borrowers took out a personal loan two times or more. TransUnion also found that the borrowers in this category were a higher risk to lenders. Of the borrowers who took out multiple loans, 60 percent of them had below prime credit. The remaining 46 percent of borrowers who just took out one loan were split equally in the credit score department. Half of these borrowers had prime credit scores while the other half had non-prime scores.
The number of borrowers taking out small unsecured loans increased by about 30 percent in recent years. In 2013, borrowers took out 10.57 million loans. During 2015, this number jumped to 13.72 million loans.
Why are More People Taking Out Low-Dollar Loans?
When it comes to taking out small loans with bad credit, CNBC reports that the loan option is attractive to borrowers who don’t have a car or home to borrow money against. While interest rates are usually higher for low-dollar loans, the repayment terms are typically shorter than they are for other types of credit like home equity loans.
With a small-dollar loan, the borrower will probably pay the money back in full within five years. Also, these lenders usually offer to deduct the payment from a borrower’s checking account automatically. This setup decreases the chances of the borrower missing a payment or defaulting on the loan.
Recent financial crises like the Great Recession and the housing crash changed the way that people borrow money. Before these incidents, many borrowers would turn to a home equity line of credit or their credit cards when they needed extra funds. Home values have dropped. It has also become tougher to get a traditional loan, making this form of credit less accessible while paving the way for unsecured loans.
People are turning to these types of loans because traditional financial institutions have stopped lending out small-dollar amounts. Banks determined that it wasn’t worth the cost of underwriting them. Along with this, banks started charging more for bounced checks and overdraft fees. Other creditors have increased late fees and over limit fees. Some even boost interest rates when borrowers are late making payments. To avoid these extra charges, people are taking out low-dollar loans to cover the minimum payments of their other financial responsibilities.
Regulations are making borrowers more comfortable taking out small-dollar loans. Because these regulations provide them with essential consumer protections, more people are requesting credit from alternative lenders.
Small Loan Borrowers Prefer Regulations
Pew Charitable Trusts reported that in a CFPB survey, respondents wanted additional regulatory action against the payday lending industry as well as more reduced-cost credit options. In fact, 70 percent of borrowers thought that more regulations would be an improvement while many of them also preferred loans with installment payment terms. Borrowers favor repayment terms of at least two to three months. They would also like to pay small loans back in lower amounts. Most of the study’s respondents were uninterested in lenders increasing the underwriting processes, meaning that they’re not really on board with lenders checking their annual incomes and other financial obligations.
Tighter Regulations Could Put a Damper on Small Loans
When it comes to taking out small loans with bad credit, tighter regulations could put a damper on the industry. There’s limited predictability for lenders who are considering entering this area of the financial sector. Part of the problem is that tighter regulations usually come with more underwriting, which encumbers lenders.
The CFPB has proposed regulations against the lenders of these loans. If the agency’s suggestions are accepted, then lenders will have to make sure that borrowers are able to repay their loans. To do this, they will need to check a borrower’s income and overall financial responsibilities.
Borrowers may soon be restricted to withdrawing three consecutive short-term loans. They may also be limited to just six a year, and if they take out a loan with repayment terms that are longer than 45 days, then the payment amount may be limited to no more than 5 percent of the borrower’s monthly income. For some small-dollar loans, the duration of the loan may be restricted to 6 months or less.
While regulatory agencies like the CFPB are not authorized to ban high-cost credit or control interest rates, federal organizations can establish conditions that lenders must follow to prevent borrowers from taking out loans that could be harmful to their financial wellbeing.
Small Loans are Accessible and Dependable
Despite regulatory assaults, the small loan industry is thriving. It is doing so because it is providing credit to those who don’t have access to it through other lenders. Not only are these loans accessible to those who are likely to be turned down for traditional loans, but it is also a dependable source of credit. Tough regulations could change the availability of small loans with bad credit. To learn more about the industry, visit the Personal Money Store.