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Installment Lenders Already Make Small-Dollar Loans Work

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With 15 million customers, the small-dollar credit market deserves a closer look. The Center for Financial Services Innovation (CFSI) study referenced by Rachel Schneider and Rob Levy in their Sept. 17 article "Banks Can Make Small-Dollar Credit Products Work" examined the behavior of small-dollar credit consumers.

While grouping products together can be useful in research, the fact remains that payday, pawn, direct deposit advance and auto title loans are vastly different from installment loans. Of the products studied, only installment loans report consumers’ payment behavior to credit bureaus – which can help them rehabilitate or build a credit history. With this in mind, installment lenders work with their customers to determine their ability to repay a loan and set an affordable payment schedule. In addition, installment loans are fully amortizing and do not require a balloon payment. There is no cycle of debt associated with them. 

Installment lenders have been successfully serving their communities with small-dollar credit for close to 100 years, and have been effectively regulated at the state level. These loans meet CFSI’s definition of "high-quality credit,"which according to the study "must be affordable, marketed transparently, priced fairly, structured to support repayment without creating a cycle of repeat borrowing and should support credit-building."

Schneider and Levy assert that banks can make small-dollar credit work, but a 2008 Federal Deposit Insurance Corp. pilot showed that they could not do so profitably. At best, deposit-driven banks and credit unions could use the products as loss leaders to bring in customers who would later use other products. Banks are welcome to enter the small-dollar credit market, but they continue to stay on the sidelines because the numbers just don’t work.

Chris Stinebert is president and CEO of the American Financial Services Association.

 

 

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Comments (5)
What's more worrying/interesting is the profile of the typical borrower, these are not hard pressed families who desperately need $100 to get through to pay day, or to buy that second hand washing machine, the typical profile of a loan customer is a 20-35 year old singleton who wants beer money, new outfit money, betting on a premiership match money, needs to upgrade the phone for the weekend, and regards $100 cash borrowing today as being worth it, even if paying back $150 next week. Loan providers lend to people who simply can't say no, they've been 'educated' to consume, they cannot control their habits.
http://bit.ly/N1y0Iq
Posted by robertq | Wednesday, September 19 2012 at 2:52AM ET
Mr. Stinebert makes important points which many continue to ignore concerning small dollar installment loans (which are not payday or title loans). Banks cannot make these types of loans at APR's that advocacy groups and some politicians want. Historically they have never been small dollar lenders because it is unprofitable, both now and as it was in the past. If a bank were to charge $25 for a one month $500 loan, the vast majority of people would deem that a very reasonable cost. Yet the APR calculation would be 60% and an inference of interest rate gouging would be claimed. Too many people mistakenly assume that an interest rate determines profit for a bank and true cost to the consumer. That is wrong. It is interest dollars that are needed to offset the lender's business cost that is the basis of profitability. It is the cost in dollars versus the benefit to the consumer that basis of the appropriateness of the charge. Until policy makers, the public, and the financial industry come to the same understanding that small dollar loans have to be viewed in the context of dollars versus APR with respect to costs & benefits, safe, affordable, and disciplined credit products will not be available to the vast majority of consumers who have a need for them. And therein lies the greatest financial tragedy.
Posted by tothepoint | Thursday, September 20 2012 at 11:15AM ET
Here are some numbers. Anybody care to challenge them?

Interest 36.00%
Less:
Cost of funds 0.35
Net Interest Margin 35.65
Less:Operating costs 3.00
Losses 18.00
Pre-tax profit 14.35
Taxes @31% 4.54
ROA 9.96
ROE (leverage of 10) 99.60%
Posted by frankarauscher | Friday, September 21 2012 at 11:04AM ET
Mr. Frankaraucher. Your operating cost assumption is considerably way off. Whether you are making a $500 loan or a $5,000 loan, the operating costs are the same. This incorrect assumption in the ROA analysis is one of the principal mistakes. ROA is an annualized analysis. If a bank were to loan $500 for one month at 36%, total interest would be $14.79. The Federal Reserve showed over 10 years ago that a lenders operational monthly loan cost easily exceeds that. Under the above incorrect ROA analysis, you would be assuming that the $500 loan would only have a operational cost to the lender of $1.23. I don't think so.
Posted by tothepoint | Friday, September 21 2012 at 3:54PM ET
Many cities struggle with dealing with growing destitute populations, but some are buying a ticket out of town for any that want to leave. More places are transferring homeless willing to go, as it often solves difficulties for all parties involved. Get an installment loan to pay for your rent and avoid being homeless.
Posted by AthenaJ | Monday, August 12 2013 at 9:49AM ET
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