The Common Ground on Short-Term Lending
Bankers are mulling new ways to serve consumers with low incomes and poor credit profiles after the crackdown on deposit advances, but the prospect of smaller profits and continuing uncertainty about regulations may dissuade a serious effort.
Before regulators go any further, they should open a public dialogue to make sure they don't do a lot more harm by eliminating the few lenders that remain.
In an era where one of the defining issues is income disparity, short-term loans primarily used by subprime and lower-income Americans have become a hotbutton issue. On one hand, consumer advocates state unequivocally that any loan greater than 36% is unacceptable and should be outlawed. The industry, on the other hand, has largely defended existing products rather than (until recently) developing better-priced, better-structured options. (Full disclosure: my company Think Finance develops short-term credit solutions, some of which we market to consumers directly and others that are offered by partners.)
But while there has been no love lost between the industry and consumer advocates, there is common ground. Both sides acknowledge that the demand for these products has expanded as banks have tightened credit standards, leaving millions of Americans with few options. As a recent op-ed from Fifth Third Bank chairman William Isaac asserted, even banks agree that eliminating what few options exist for underserved consumers without creating new ones simply isn't viable. What we need is a more productive dialogue between industry players, consumer groups and regulators. Instead of dwelling on tried and tired arguments, we should focus on ideas that everyone can support that will ultimately protect access to credit for Americans in need.
End the cycle of debt. The best way to eliminate the "cycle of debt" concern is to require principal reduction with each payment over a longer repayment period. It's time for an industrywide shift from single pay payday loans to installment loans and lines of credit, along with requirements that borrowers make progress on their loans every month. States must come to the table and change their laws to enable this goal.
Help consumers make better decisions. One of the biggest appeals of short-term loans is their simplicity and lack of hidden, although often high, fees (unlike credit cards, for instance). Nonetheless, our industry should hold itself to higher standards. Lenders should provide financial literacy tools to potential borrowers, help them ask the right questions to determine if the loan is the best financial option and educate consumers on the implications of non-payment.
Give the consumer time to back out. Most lenders allow customers only one day to rescind their loan. Given the extreme financial pressure consumers are often under when they choose their loan and lender, it is important to give them enough time to decide if the product is right for them, or if a lower cost form of credit exists. A period of five days would give borrowers the time they need to determine if a loan is the right choice.
Help customers build credit so they can get lower-cost loans. Because most short-term lenders don't report to major credit bureaus, consumers are never able to improve their credit options. This needs to change. Credit bureaus should be required to integrate payment history into their credit scores and not discriminate against customers who select alternate forms of credit. Likewise, lenders should use payment history to lower prices for their customers.
Be understanding when customers can't pay on time. Consumers using short-term credit products have a higher propensity to miss their payments. Lenders should provide grace periods of up to one week and not charge late fees. There should be no place for aggressive collections tactics such as garnishing wages or civil or criminal lawsuits against consumers in this industry.
Many of the current prescriptions for change merely constrict innovation and reduce access to credit. Affordability limits, for instance, while well-intentioned, are unrealistic based on most borrowers' needs. If loan payments are capped at 5% of income (as a recent Pew study recommended), the average American would be limited to $60 in loan payments per biweekly pay period, (based on a $31,000 annual income, as noted in the Pew report). This would severely limit loan amounts and paradoxically cause lenders to extend the terms of the loans to absurd lengths. Arbitrary rate caps also only serve to eliminate access to credit. While prohibition has a certain moral appeal, the reality is that for the millions of Americans facing unexpected bills, the most expensive credit is no credit at all.
Access to credit is a financial lifeline for Americans facing economic stress. There should be a concerted effort among consumer groups, regulators, industry and legislators to ensure not only that these loans meet the highest standards of transparency and responsible lending, but that there is opportunity and encouragement for developing new credit products. Let's stop grandstanding and begin focusing on common ground ideas that can transform this needed industry.
Ken Rees is president and CEO of Think Finance, a developer of alternative short-term credit products.