There is a substantial growth opportunity for consumer unsecured loan market participants. Amid a backdrop of record high
The American economy is facing record high levels of credit card debt and skyrocketing credit card rates, increasing fears of
One route out of this situation is through consumer unsecured loans. By refinancing their credit card debt, American households could save huge amounts of money. First, the online lending sector is designed for borrowers to rapidly pay down debt, with strict terms of amortization, typically three to five years. By contrast, credit card debt barely amortizes and is designed to be paid over 12 to 15 years or more. Second, interest rates on consumer unsecured loans have risen far less than credit cards. Historically, consumer unsecured loan rates were consistently around 2.5% below credit card rates from 2017 to 2022, but that difference has soared to 6% over the past year. This difference means that by transitioning from credit cards to installment loans, borrowers can lower their monthly payments and rapidly pay down their debt. By refinancing in this fashion, U.S. households, primarily low- and middle-income households, could collectively save over $60 billion per year. The savings would be more than enough to negate all consumer credit growth for the bottom 40% of income households over the past year, estimated at $47 billion by the Federal Reserve.
The only problem is that participants in this market have been influenced by fears of unhealthy consumer balance sheets, and as a result, originations have declined. The sector has seen significant performance deterioration — going from record low to record high impairment and charge-off rates within the past two years. A combination of performance trends and fears of rising rates has led to a substantial decline in loan volumes and more limited refinancing options. This, in turn, has led to a feedback loop of fewer originations and even worse aggregate performance.
The number of government-backed home loans transferred from one borrower to another is up significantly this year as prospective buyers look for ways to avoid elevated interest rates. Some say this is the beginning of a larger movement, but others say regulatory hurdles will get in the way.
However, these fears are inflated. Consumer debt service payments remain historically low and have actually declined in recent quarters despite rising nominal debt amounts. Those declines have been spread across both mortgage and consumer debt, despite still rising interest rates, according to the Federal Reserve. Moreover, consumer wealth levels continue to rise, despite stock market and home price fluctuations. Wealth levels for lower income households have reached record levels and can be used to significantly support consumption spending, as reported by the Federal Reserve.
By ignoring the benefits of the consumer unsecured sector, an opportunity set is left unappreciated, and Americans are locked out of potential savings. The consumer unsecured sector continues to offer strong, risk-adjusted, short-duration returns. Were we to see a material increase in the uptake of installment lending from both consumers and investors, it would give issuers and investors the flexibility to raise rates (while still maintaining near record spreads versus credit cards) while experiencing material growth volumes, creating a replicable, scalable portfolio with reasonable risk-adjusted returns. For borrowers it would allow significant cost savings, financial flexibility and a more rapid path out of debt and toward a more sustainable financial future.
Many Americans are looking for a solution to the record high credit card debt and rates levels. This solution is the consumer unsecured sector: By refinancing their credit card debt, Americans can see real savings. If the online lending universe — investors, originators and borrowers themselves — work together, they can improve the sector and increase financing options for Americans at a time when they need them most.
