A recent study released by the Center for Responsible Lending (CRL) is the latest in a long series apparently aimed at eliminating non-bank credit in our nation. This one is different to those that have gone before, in that it introduces the strange new loan category of “high-cost installment loan”.
CRL’s focus had previously been primarily on problematic payday and title loans. Their new loan category appears to be an effort to expand that campaign by blurring the lines between installment and payday loans. This would allow a one-size-fits-all approach to regulation, in the form of onerous state Annual Percentage Rate (APR) limits that make all forms of non-bank lending impossible.
Recent laws along these lines in Illinois and New Mexico have effectively eliminated non-bank credit overnight. This has compounded the hardship caused by the COVID-19 pandemic, inflation, and diminished job security. With this latest survey, CRL seem to be urging more states to follow suit.
Avoiding the Cycle-of-Debt
Critical differences in types of loan require different approaches to regulation. In recent years, the main impetus for state lending laws, and the subject of much of CRL’s ire, has been the so-called cycle-of-debt. This occurs when payday or title loan borrowers who cannot make the single “balloon payment” to repay their loan, have no option but to renew it, often many times.
Installment loans avoid the cycle-of-debt through regularly scheduled, manageable installments of principal and interest. This gives borrowers a roadmap to pay down their debt and decreases the likelihood that they will be forced to renew their loan. For this reason, even CRL itself once considered them a safer form of credit.
There are other differences too. Many installment loans do not require any kind of collateral. They are underwritten (the claim of a lack of underwriting in the CRL study is not accurate) and lenders assess the borrower’s ability-to-repay the loan from their monthly budget, prior to extending credit. Critically, installment lenders also report to credit bureaus, helping raise the credit scores vital to financial mobility.
Illinois and Overreaching Laws
These beneficial differences are being ignored by CRL and by states like Illinois. According to the FDIC, nearly a million people in Illinois are unbanked or underbanked, with severely limited access to bank credit. The American Financial Services Association (AFSA) has highlighted research that shows that Illinois new rate cap law reduced loans to subprime borrowers by 36% and to deep subprime borrowers by a staggering 57%. It is excluding thousands of Illinois families from the lending market, with all the hardship that entails. This is despite the claims by Pollyannas in the Chicago press that credit unions will pick up the slack.
The fact is, 36 percent APR is lower than the break-even point for a lender. According to the Fed, a lender would need to make a $2,530 loan to break even at 36 percent APR. Many borrowers do not need to borrow that much, and no lender could meet the cost involved in offering smaller loans at that rate. Costs associated with underwriting alone would exceed this. Factor in local offices, utilities, and payroll and you begin to understand the challenge.
Self-Help Credit Union
The idea that credit unions will pick up the slack when non-bank lenders are eliminated is a pipedream. This is simply because they cannot do so profitably. To take Self Help Credit Union – a CRL affiliate – as an example, “rates” for loans advertised online are up to 16 percent. While these are presumably for loans larger than the $2,530 threshold noted by the Fed, Self Help nevertheless also has a cushion, in the form of the raft of fees for additional services, including for account fees, check cashing fees, coin deposits, statement histories and more. Often, its loans also require collateral. There is nothing wrong with these practices, of course, but they do serve to make it difficult to tell whether a borrower is better off with a Credit Union loan of this kind or with a traditional installment loan, even if they could manage a larger loan and qualify for a credit union account in the first place.
A Policy Solution for Lawmakers
In the past, installment lenders have been seen as a policy solution for lawmakers who wish to deal with the cycle-of-debt, while maintaining wide credit availability. CRL’s research cuts across this balanced approach to lawmaking, casting doubt on the worthiness of installment loans. This potentially increases the likelihood that states will seek a single policy solution that does not differentiate between loan types. This will result in huge credit deserts, leading not, as CRL would have you believe, to cheaper credit, but in fact, to not credit at all.
This must not happen. Policymakers should carefully consider the real-world consequences for individuals and families. Removing a valued financial capability from a whole section of society will create hardship and suffering. It must not be done lightly.
It certainly should not be justified by CRL’s rather peculiar study.