Building a safety net for when the consumer debt balloon pops
It's never too soon for bankers to start worrying about rising consumer delinquencies.
While households are generally keeping up with their loan payments, they are also taking on more debt than ever, running the risk of becoming overextended.
Total household debt hit an all-time high of $13.5 trillion in the third quarter, and while delinquency rates on credit card and car loans are nowhere near crisis-era levels, they have been trending up of late, according to data from the Federal Reserve Bank of New York.
Factor in slow wage growth, high housing costs and low personal savings rates among working-class families, and it is easy to imagine many households falling behind on their monthly bills if the economy sours, or if they are faced with a sudden financial shock, such as divorce or a major medical expense. Some will even wind up in bankruptcy.
So what can banks do to help customers dealing with unsustainable levels of debt avoid bankruptcy? Often, they will refer a customer to a third-party debt consolidator, which will then lend that customer the money to pay off various loans and consolidate the debt into a single payment.
The problem with that model is that some borrowers will wind up in even deeper debt. The reason: Debt consolidators do not require their clients to close out credit card accounts they have just paid off, so it's not uncommon for these clients to max out their credit cards again.
LendStreet, an Oakland, Calif., startup, is a different kind of debt consolidator. Founded in 2013 by Jerry Nemorin, a former Wall Street investment banker, LendStreet doesn't just consolidate a borrower's debt, it negotiates with creditors to reduce the debt by an average of 30%. So a consumer who has, say, $30,000 in debt spread across six credit cards, will see his outstanding debt reduced to $21,000. Interest rates on its loans range between 14.95% and 17.95%.
LendStreet also requires its clients to cut up most of their credit cards (they can keep one or two for emergencies) so that they aren't tempted to live above their means.
Nemorin hit upon the idea of creating LendStreet while working on Wall Street and helping a media company restructure its debt. If corporations can reduce their debt by negotiating with creditors, he thought, why can't consumers?
"This was during the financial crisis, and many consumers were in distress," Nemorin said. "There was no solution out there that was comprehensive and sophisticated enough to help them work through their problems, much like we were doing on Wall Street for major companies."
Nemorin quit his job in 2010 to focus full-time on building out his idea and raising venture capital. He launched LendStreet in 2013. In the years since, LendStreet has helped roughly 1,000 consumers restructure $27 million in debt. Nemorin said that customers need about four years to pay off their debt, but noted that most have seen their credit scores rise by an average of 80 points within a year of signing on with LendStreet and 100 points within 18 months.
The firm has gained the backing of some prominent investors, including Prudential Financial, which last year led a $117 million venture funding round. Other backers include Radicle Impact, the mission-based venture fund run by billionaire hedge fund manager Tom Steyer and his wife, banker Kat Taylor; and Kapor Capital, the venture arm of the Kapor Center for Social Impact established by Lotus co-founder Mitch Kapor.
LendStreet has caught the attention of the Center for Financial Services Innovation, which works with fledgling fintech companies to help build financial products geared toward unbanked, underbanked and financially distressed consumers. When CFSI launched its innovation lab for promising startups four years ago, LendStreet was in the first cohort. It received eight months of consulting services from CFSI as well as a $250,000 equity investment.
The funding in place, Nemorin is now looking to secure more referrals from bankers, who he believes need to be bracing themselves for an inevitable downturn in the economy. While the LendStreet model means that banks might have to take a discount on what's owed to them, the upside, Nemorin said, is that consumers will emerge more financially healthy in the long run because they have kept up with their payments and didn't rack up more debt. He said that roughly 10% of LendStreet loans are paid off early because customers have improved their credit enough to qualify for lower-cost home equity loans.
"What we want to get across to creditors is that we are here to be a partner," he said. "Our focus is helping banks recover as much as possible, while rebuilding customers so they can come back into the financial system."