Installment Loan Organization | Green Day Online
The majority of organizations offer installment loans. These loans can be repaid over time and are secured by access to the borrower’s checking account. This is in addition to traditional payday loans, which are due in one lump sum.
The shift to installment lending is widespread geographically. Payday or auto title lenders can now issue such loans or lines of credit in 26 out of 39 states.
Green Day Online research and others have shown that conventional payday loans are not affordable for most borrowers.
They also encourage repeat borrowing and lead to indebtedness that lasts much longer than is advertised. In June 2016, the Consumer Financial Protection Bureau (CFPB) proposed a rule to regulate the auto title and payday loan markets.
It required that most small loans be repaid in installments. A Colorado structure that required loans to be paid overtime, combined with lower price limits, was shown to reduce consumer harm.
After the state passed legislation in 2010, requiring all payday loans to become six-month installment loans.
National survey data shows that 79 percent of payday borrowers favor a similar model to Colorado’s. In which loans are paid in small installments and take only a portion of each paycheck, this is a popular option. A similar requirement is supported by seventy-five percent of the public.
Payday installment lending is a growing trend to get ahead of the CFPB and bypass state-level consumer protections. This installment lending can be dangerous, even though it is legal today.
This short describes the unique practices in the payday installment loan marketplace and those primarily found in the traditional subprime loan market. It focuses on four things that threaten the integrity and subprime small-dollar loan markets.
These include unaffordable repayments, frontloaded fees that increase costs for borrowers who refinance or repay early, excessive lengths, and unnecessarily expensive prices.
The federal and state policymakers need to act immediately to create policies that will benefit consumers and encourage responsible lending.
Green Day Online’s research has shown that regulators can reduce harmful practices by limiting payment sizes, requiring that all charges are spread evenly over the loan term, limiting loan terms to six months, and setting price limits that are affordable for borrowers.
Lenders who operate efficiently, and provide clear regulatory pathways for low-cost providers such as credit unions and banks to issue small loans.
Many of these protections can be implemented by the CFPB. It does not have the power to limit interest rates.
Therefore, although lump-sum lending will be greatly curtailed once the rule is in effect, high-cost installment loans will likely continue to be issued until states regulate them.
Policymakers need to address subprime and payday installment loans as the transition towards longer-term lending continues.
Why installment loan organizations are shifting away from lump-sum loans
Three factors drive the trend of payday and auto title organizations to offer installment loans: consumer preference, regulatory pressure, and lenders’ efforts to ignore consumer protections for lump-sum payments loans.
Preferences of the consumer
Green Day Online’s research has shown that payday loan customers prefer an installment repayment structure to the traditional lump-sum model. This allows them to pay off loans more quickly and in smaller amounts that are affordable for them.
One installment loan organization stated, “I learned in Colorado our consumers like affordability,” and pointed out the industry’s likely shift in this direction.
According to the head of an online organization trade association, most members switched from two-week lump-sum loans to installment loans due to consumer demand.
Federal banking regulators issued guidance in 2013 disabling banks from issuing lump-sum “deposit advances loans,” similar to conventional payday loans. A proposed rule by the CFPB for payday loans and similar loans stresses the importance of affordable monthly payments. If finalized, the rule would accelerate the transition to installment loan structures.
Payday lenders supported bills in Arizona, Indiana, and Mississippi to allow high-cost installment loans. Industry consultants also noted that the CFPB’s pending regulation encourages a shift towards installment lending.
One consultant noted that many payday consumers today can easily handle an installment loan at yields that mimic a payday loan and encouraged the industry lobbying to change state laws to allow “high-yield” installment products.
To avoid consumer protection laws, some lenders have made the switch to installment loans. In Delaware, a law that limited the number of payday lenders may make to a borrower within 12 months to five was put into effect in 2013.
Companies began to offer installment loans for more than two months in addition to conventional two-week payday loans. Because the law defines “short term” as less than 60 days, this allowed them to avoid the new limit.
Another example is the Military Lending Act of 2007. This law limited interest rates for loans to military personnel to less than 91 days. Therefore, lenders started making loans of at least 92 days to increase their rates. Lenders used similar tactics in New Mexico, Illinois, Wisconsin.
High-Cost Installment loans could proliferate under the CFPB Rule.
In 26 of the 39 states they serve, payday and auto title lenders have already issued high-cost installment loans or credit lines in high-cost amounts.
In June 2016, the CFPB proposed a rule. After the rule is finalized, lump-sum lending will be more restricted. Lenders will likely accelerate their efforts in expanding high-cost installment loans into other states once that is done.
This is likely to happen in two ways. They will likely try to change laws in states that don’t allow installment lending. Lenders have not had much incentive to push for this change until now.
They could only issue auto title loans and lump-sum payday loans. But as the market becomes smaller, they will be more motivated to expand the availability of high-cost installment lending.
They may also use credit services organization (CSO), which allows the brokering and sale of loans in states with such laws.
This brokering can be used to evade low-interest rates. The fees are additional to the interest charged to third-party lenders and substantially increase the cost to borrowers.
Payday and auto title lenders are not permitted to issue lines of credit or installment loans in some states. However, there may be CSO statutes that the lenders could use to bypass consumer protections.
At least 32 states where payday and auto title lenders are licensed could be at risk of high-cost auto title or payday loans.
How regulators can address these four major problems with installment loan organization
The majority of installment payday loans have monthly payments that are higher than what most borrowers can afford. Unaffordable monthly payments can cause the same problems as conventional lump-sum loans: overdrafts, frequent reborrowing, and the need to raise cash to pay off debt.
The number of monthly installment loans payable over the five percent of borrowers’ income is often much higher than what they can afford. Lenders can access borrowers’ checking accounts electronically or with postdated cheques so that they can collect installments regardless of borrowers’ ability.
In the same way, lenders can repossess auto title loan customers’ vehicles to force them to make high-interest loan payments. This can lead to consumers not being able to pay their basic expenses.
Policymakers should make loans affordable and repayable in small amounts to solve the problem of unaffordable repayments. Payouts should not exceed 5 percent of a borrower’s monthly income to be affordable for payday loans.
A second solution is for lenders to perform underwriting to determine borrowers’ ability and willingness to repay. This approach is risky because it does not adhere to clear product safety standards. For example, lenders may limit loan payments to 5% of a borrower’s monthly income.
Lenders may be liable for additional costs, which can increase the cost of loans. Lenders have little incentive to make sure payments are affordable because they can access borrowers’ checking accounts and car titles.
Charges for front-loaded services
Lenders are expected to charge an upfront fee to process an application for credit or originate a loan. However, in subprime consumer finance installment loan markets, lenders often charge large upfront origination fees to process an application or originate a loan. This can cause significant financial harm to consumers and increase the loan’s cost at issue.
It also penalizes borrowers who default on their payments. Lenders can earn additional origination fees by increasing their revenue.
Refinance offers for small-loan borrowers can be particularly attractive because they are often low- or moderate-income and have little savings.
This misalignment has resulted in widespread refinancing or “loan flipping” in the traditional subprime small-installment loan market. Refinances account for approximately three-quarters of the loan volume for one lender.
On an earnings call with investors, the CEO of one company explained that customer service representatives get a bonus based upon how many customers they refinance. This is because encouraging renewals in our business is very important.
This will solve the problem of finance charges such as interest and fees being spread out over the loan’s life rather than being imposed upfront.
This helps borrowers avoid paying large fees upfront and aligns the interests of lenders and borrowers by ensuring profitability, affordability, and encouraging early payments. It also encourages lenders to help borrowers refinance.
Colorado’s 2010 payday loan statute reform allowed for an origination fee, but lenders were required to refund pro-rata borrowers who prepay. This was crucial to the state’s success because lenders didn’t encourage borrowers to refinance loans.
High-interest installment loans can have unreasonably long terms. Only a small percentage of each payment reduces the loan balance.
Borrowers with unstable incomes are at greater risk if they have to borrow for extended periods. They may not be able to pay their loan payments in lower-income months.
However, lenders have access to their checking accounts and car titles, so they have no choice. Green Day Online’s research found that six months is sufficient to repay a $500 loan even at higher interest rates, and one year is enough for a $1,000 loan.
For a $500 loan, people consider very short terms (less than a month) and very long terms (more like a year) unreasonable.
As longer-term installment loans become more common, it will be essential to discourage excessive loan terms. Clear guidelines will be required in the final CFPB rule regarding payday loans and similar loans.
States that amend their existing payday or installment loan statutes need to have policies that discourage excessive lengths.
According to the CFPB, certain longer-term alternative loans should have terms of between 45 days and six months.
This is consistent with Green Day Online’s findings regarding the number of times borrowers must repay loans, with public opinion on reasonable lengths for $500 loans.
Small-dollar loan programs were created by the Federal Deposit Insurance Corp. and National Credit Union Administration. These programs give borrowers many months to repay.
High prices are unnecessarily
The prices in the auto title and payday loan markets are much higher than necessary to guarantee credit availability and profitability.
Research shows that borrowers are often in financial distress and focus on how much they can borrow and how fast they can get the funds. Lenders compete on price and customer service.
Lenders cannot make a profit and ensure that credit is available to all consumers, so prices remain high. Rate limits are needed to lower prices and encourage safe payday and auto-title loans. The price limit for small-dollar loans is set by 46 states and the District of Columbia.
Policymakers can use two strategies to encourage credit at reasonable prices. First, you can limit interest rates and fees. Lenders have continued being profitable after they have established limits that are lower than current payday loan prices but still above the traditional usury rate thresholds.
Credit has also remained easily available. For a total of $116, policymakers can limit interest rates and fees to a slightly lower level than the Colorado rate. A typical payday installment loan of $389 costs just $389 and has 121 percent.
Regardless of what the CFPB final rule says, state policymakers can make a reasonable decision to ban payday and auto-title loans from their states.
This can be done by limiting finance fees to 36 percent (inclusive of all fees). This practical approach has been used in the past for loans larger than this and will prohibit these lenders from operating.
To lower loan prices, the second strategy is to allow smaller-cost lenders to offer small loans. Because they are diversified businesses, banks and credit unions can offer large competitive advantages over payday and auto title lenders.
They could also lend to their customers instead of paying for new customers, borrow from their customers, and have low costs of funds.
These financial institutions can profitably offer small loans at double-digit APRs for prices six to eight times less than payday lenders. However, to offer these loans sustainably, the banks’ fee-inclusive rates will need to be slightly higher than 36% APR.
Banks and credit unions will need to use clear and straightforward underwriting standards to issue small loans profitably. This would include a cap on monthly loan payments at 5 percent of monthly earnings and loan terms of six months.
Banks could also take steps to ensure that very low credit risk applicants are making regular deposits and using a credit union or bank accounts in good standing.
Green Day Online estimates that banks could offer a $400 three-month loan for -60, half the cost of Colorado’s current payday installment loans.
Payday loan markets are moving away from lump-sum lending to favor installment loans. This shift is partly driven by consumer preference and regulatory pressure.
However, lenders have used installment loan models to evade consumer protections that only cover short-term loans in some cases.
Although the CFPB’s small-dollar loan rule proposal will likely accelerate this transition, consumers must be able to afford it and have reasonable terms.
Federal and state policymakers need to take further steps to address the four main problems in the small installment loan market. These include unfeasible payments, high loan refinance rates, excessive lengths, and noncompetitive pricing.
These problems can be addressed by making payments affordable based on the borrower’s income. It is also limiting the length of small-dollar loans to six months in most cases and limiting prices to a sustainable level for lenders and borrowers that are efficient, and allowing low-cost providers like banks and credit unions to continue to offer small loans.
Green Day Online reviewed all state statutes regarding payday, auto title, and pawn loans, as well as those of payday and auto title lenders.
Green Day Online reached out to state regulators in every state that did not clarify whether or not payday installment loans, installment loans for auto titles, or other lines of credit were being offered.