The calculation of the loan is relatively simple. An institution, whether it is a bank or some other type of lender, has access to funds at cheap rates. It lends these funds and usually adds an interest margin.
The margin covers the cost of funds used to lend, the operational costs of the loan and the risks associated with it. In other words, net income = interest income – interest expense – net non-interest expense.
It’s that simple.
Now think of a basic bell curve, and you can see how FICO scores play a role in deciding who gets credit and who doesn’t. For the lowest 20%, you have the highest credit risk. It represents those with poor credit, low income or difficult work history; for the top 20%, you have the reverse.
The remaining 60% are close to the first or first.
If you’re working out pricing for a basic Bank of America Cash Rewards card, Chase Freedom card, or Discover It card, you’ll focus on the 60% group. It is the American consumer credit market, with approximately 80 million households.
There are many potential customers for the many credit card issuers in the United States. The richest 20% are more likely to qualify for card products such as the Bank of America Premium Rewards card, Chase Sapphire, or a premium Discover It card.
But, for the bottom 20%, we have an inordinate credit risk. Included in this group are those who are undocumented or low-income with limited repayment capacity, those who have failed to manage their previous credit responsibilities, and those who may have extended their credit too much.
But, they still need credit to manage their household budget.
With that in mind, think of an unexpected financial event like a broken down car, medical emergency, or other household crisis. If you are Joe or Jane Consumer, there may be an immediate need for a temporary financial bridge, which puts us to the credit of today. story from the Los Angeles Times.
The LA Times talks about the emergence of online installment lenders to serve this niche. The point is, American consumers have over $ 150 billion in installment loan debt, ranging from cheap financing at Walmart to Affirm to 5-figure debt consolidation loans from Marcus of Goldman Sachs.
But the group that interests us today are consumers somewhere in between, with poor credit and in need of short-term cash flow.
- It’s called the online installment loan, a form of debt with much longer maturities but often the same kind of crippling triple-digit interest rate.
- If the target audience for the payday loan is the poor nationwide, then the installment loan is for all working-class Americans who have seen their wages stagnate and unpaid bills pile up in the years since. the Great Recession.
- In just five years, online installment loans have grown from a relatively niche offering to a booming industry.
- Non-privileged borrowers now collectively owe about $ 50 billion in installment products, according to credit reporting firm TransUnion.
- In the process, they help transform the way much of the country accesses debt. And they did so without attracting the kind of public and regulatory backlash that has harassed the payday loan.
- “Installment loans are a cash cow for creditors, but a devastating cost for borrowers,” said Margot Saunders, senior counsel for the National Consumer Law Center, a nonprofit advocacy group.
Eeew: The payday loan.
- Yet the change has come with a major consequence for borrowers.
- By changing the way clients repaid their debts, subprime lenders have been able to bypass growing regulatory efforts to prevent families from falling into debt traps built on sky-high fees and endless renewals.
- While payday loans are typically paid off in a lump sum over a matter of weeks, installment loan terms can range from four to 60 months, apparently allowing borrowers to take on larger personal debts.
Online installment loans are superior to payday loans.
For subprime lender Enova International Inc., installment loan outstandings averaged $ 2,123 in the second quarter, compared to $ 420 for short-term products, according to a recent regulatory filing.
- Larger loans have allowed many installment lenders to charge triple-digit interest rates. In many states, Enova’s NetCredit platform offers annual percentage rates between 34% and 155%.
- Between Enova and rival online lender Elevate Credit Inc., installment loan write-offs in the first half of the year averaged around 12% of total outstanding amounts, well above the 3.6% of the credit card industry.
- “With high cost credit, you’re only serving people who won’t qualify for other types of credit, so you’re already in a tough spot,” said John Hecht, analyst at Jefferies LLC. “Companies have to set a price for it. “
The bell curve works in credit, allowing you to contain costs; risk is an expense that lenders must allocate directly to those presenting it. The costs will be higher for riskier loans. The facts are simple and although Shakespeare’s advice by Polonius in Hamlet may sound harsh, that says a lot.
“Neither borrower nor lender is; / Because the loan often loses himself and his friend.
Preview by Brian riley, Director, Credit Advisory Service at Mercator Advisory Group