Yves here. The kinder, gentler payday lending, reincarnated as installment loans, still looks an awful lot like loan sharing minus brass knuckle collections.
By Paige Marta Skiba, Professor of Law, Vanderbilt University and Caroline Malone, Ph.D. Student in Law and Economics, Vanderbilt University. Originally published at The Conversation
Installment loans seem like a kinder, gentler version of their “predatory” cousin, the payday loan. But for consumers, they may be even more harmful.
Use of the installment loan, in which a consumer borrows a lump sum and pays back the principal and interest in a series of regular payments, has grown dramatically since 2013 as regulators began to rein in payday lending. In fact, payday lenders appear to have developed installment loans primarily to evade this increased scrutiny.
A closer look at the differences between the two types of loans shows why we believe the growth in installment loans is worrying – and needs the same regulatory attention as payday loans.
At first glance, it seems like installment loans could be less harmful than payday loans. They tend to be larger, can be paid back over longer periods of time and usually have lower annualized interest rates – all potentially good things.
While payday loans are typically around US$350, installment loans tend to be in the $500 to $2,000 range. The potential to borrow more may benefit consumers who have greater short-term needs.
Because installment loans are repaid in biweekly or monthly installments over a period of six to nine months, lenders say consumers are better able to manage the financial strain that brought them to their storefront in the first place.
Payday loans, in contrast, typically require a lump sum payment for interest and principal on the borrower’s very next pay date, often just a few days away. Lenders offer cash in exchange for a post-dated check written from the borrower’s checking account for the amount borrowed and “fees” – what they often dub “interest” to skirt usury rules.
Finally, and perhaps most importantly, installment loans are often cheaper than payday loans, with annualized interest rates of around 120% in some states, compared with payday loans’ typical 400% to 500% range.
Harmful to Consumers
Unfortunately, some of the structural features that seem beneficial may actually be harmful to consumers – and make them even worse than payday loans.
For example, the longer payback period keeps borrowers indebted longer and requires sustained discipline to make repayments, perhaps increasing stress and opportunities for error.
And the fact that the loan amounts are larger may cut both ways.
It is true that the small size of payday loans often isn’t enough to cover a borrower’s immediate needs. About 80% of payday borrowers do not repay their loan in full when due but “roll over” their loan into subsequent paycheck. Rolling over a loan allows borrowers to repay merely the interest, then extend the loan in exchange for another pay cycle to repay at the cost of another interest payment.
In a recent study, we explored the effect that the larger installment loan sizes have on borrowers. We used a dataset containing thousands of installment loan records in which some borrowers received a larger loan because they earned a higher income. Although similar in terms of factors such as credit risk and income level, slightly higher-income borrowers were offered a $900 loan, while others got only $600.
We found that borrowers with those larger loans were more likely to have subsequently taken out debt on other installment loans, storefront and online payday loans and auto title loans. Our results suggest that the higher initial installment loan might not serve its main purpose of helping borrowers manage their finances and actually may have caused increased financial strain.
Misuse and Abuse
As some of our previous research has shown, even payday loans, with their sky-high annualized rates and balloon payments, can be beneficial to consumers in some instances.
Installment loans are no different. When used carefully, they can help low-income consumers with no other credit access smooth consumption. And when they are paid back on time, the loans can certainly provide a net benefit.
But their nature means they are also rife for misuse and abuse. And any negative effects will apply to a broader group of consumers because they are deemed more “mainstream” than payday loans. Lenders are targeting consumers with higher credit scores and higher incomes than those of the “fringe” borrowers who tend to use payday loans.
Installment lending accounts for an increasingly large portion of the alternative credit industry. If regulatory crackdowns on payday lending continue, installment lending is likely to become the bulk of lending in the small-dollar, high-interest lending market.
Given the current lack of regulation of these types of loans, we hope they receive increased scrutiny.
Oh boy. If this iteration of loansharking follows the historical pattern, we will have a re-immiserated ‘lower strata’ of society. Payday Loans and Auto Title Loans are bad enough, and by bad, I mean exploitative. Throw an ‘interestingly’ complicated financial instrument like an Installment Loan at a financially ignorant person and you have the classic “criminogenic environment.”
What I don’t understand is why the Banks and Credit Unions aren’t all over this group of “customers.” Isn’t there a banking scale covering loan size versus credit risk already? I mean, when looked at from a slightly different angle, the banks must already have some metrics in place simply in order to ‘justify’ denying credit to their potential lower class ‘customers?’
Could Post Office banking be a partial cure? It might end up as a back door for the introduction of a Hamiltonian “National Bank,” but the intended uses for such an entity would be the selling point.
I await ‘correction’ since I am one of the dullest tools in this kit.
None of this should be legal. Seven words into your response nails it: it’s loansharking. Further, any politician actively taking money from any of entity in this “industry” should be disqualified from holding public office.
Is this a sly reference to the old SNL skit series about Mango, the ‘Exotic Dancer?’
LOL … You have no idea. SNL “Mango” was a favourite, but in this case, just me trying to respect the language standards of this website … ;-)
Mariner Eccles, FED chair 1934 – 48, observed what the capital accumulation of neoclassical economics did to the US economy in the 1920s.
“a giant suction pump had by 1929 to 1930 drawn into a few hands an increasing proportion of currently produced wealth. This served then as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied themselves the kind of effective demand for their products which would justify reinvestment of the capital accumulation in new plants. In consequence as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When the credit ran out, the game stopped”
The problem; wealth concentrates until the system collapses.
“The other fellows could stay in the game only by borrowing.” Mariner Eccles, FED chair 1934 – 48
Your wages aren’t high enough, have a Payday loan.
You need a house, have a sub-prime mortgage.
You need a car, have a sub-prime auto loan.
You need a good education, have a student loan.
Still not getting by?
Load up on credit cards.
“When the credit ran out, the game stopped” Mariner Eccles, FED chair 1934 – 48
Still not getting it?
Neoclassical economics brought capitalism to its knees in the 1930s.
“Everything is getting better and better look at the stock market” the 1920’s believer in free markets
Sound just like Trump now, doesn’t it?
“Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.
This 1920’s neoclassical economist that believed in free markets knew this was a stable equilibrium. He became a laughing stock.
Better shelve this for a few decades until everyone has forgotten.
Now everyone has forgotten we can use it for globalisation.
Do you really think that is a good idea?
We were walking down the main drag in Hurricane, Utah some years back, and a payday loan place had a clipping from a SLC newspaper in their window that showed the establishment had the lowest apr in the state @ 306% that were rightly proud of, with the highest loanshark coming in @ 812% in the Beehive state.
…unintentional comedy is the best kind
That Hurricane aftermath shows the mysterious workings of the free market. The 306% threshold is obviously the rock bottom bare minimum rate to induce an entrepreneur to invest accumulated capital, taking on all risks of repayment uncertainty.
It is a wonder that more hardy souls are not clamouring to enter that neglected business, although one cost of doing such business is selling said souls. That has to be what pushes up those thresholds. There must be Wall Street interns modeling soul derivatives and swaps, if they haven’t outsourced that to an AI lab.
If only there were some way to identify the brave lenders before they jump sharks. Their mothers must be so proud.
“may benefit consumers who have greater short-term needs”
“consumers are better able to manage the financial strain that brought them to their storefront in the first place.”
Yes… I am absolutely positive that these saints of the financial sector are doing this entirely so that they will ultimately suck less money out of the unfortunate people who are desperate enough to need their services. That totally makes sense! /s
And I hear Uber is planning to enter the field too by lending to its “independent contractors” when they need money – and they will apparently accept repayment by deducting directly from the driver’s revenue. What a swell bunch!
So many ways to mine income for wealth accumulation, at least until the credit runs out. Anyone know a composer who could do justice to “Debt Peonage: Theme and Variations”
Along with other ethical finance* reforms, an equal Citizen’s Dividend to replace all fiat creation beyond that created by deficit spending for the general welfare should greatly reduce the need to borrow in the first place.
But who wants ethical finance??
So blame yourself for the plight of the poor if you oppose ethical finance.
*including land reform to deal with the problem of rentiers.