The Need is Real for Affordable Short-Term, Small-Dollar Loans
Despite a record-low 3.8 percent unemployment rate, American consumers still have difficulty meeting immediate and emergency living expenses. The demand for short-term liquidity is, in fact, staggering with 78 percent of consumers living paycheck to paycheck1 and 40 percent unable to cover a $400 emergency.2
For some, overdraft is a reasonable option that most financial institutions offer. According to the Consumer Financial Protection Bureau (CFPB), 8–12 percent of account holders pay about 80 percent of all overdraft fees.3 Of these, the majority make an informed choice to do so —”trading off the cost of short-term overdraft funding against benefits such as payment timing and certainty,” according to Novantas research.4
Consumers who opt to use overdraft protection as a safety net want to swipe their debit cards and have the assurance that their financial institution will cover their transactions even if they do not have the available funds at the time.
However, other consumers in need of short-term liquidity prefer to have the money in their accounts prior to needing the funds. These consumers tend to manage their money proactively and balance their checkbooks regularly. So, when funds fall short for them, what are their options?
Traditionally, these consumers have relied on alternatives outside the banking system, including check cashing, pawn shops and payday lenders, which often charge 400 percent APRs or more. Many of them struggle to pay their household bills on time, resulting in exorbitant late fees and negative hits to their credit score, impairing their ability to acquire more affordable sources of liquidity. As a result, each year 12 million Americans (including about 15–20 percent of a financial institution’s account holders) take out payday loans5, spending $9 billion on loan fees5 to cover their income gaps.
The Case for Loan Automation
While many credit unions may see the value in serving this overlooked consumer market, it has not made sense due to cost-prohibitive manual small-dollar loan processes that require resources that most community institutions cannot justify.
Luckily, meeting the challenge of providing affordable liquidity is now obtainable through the use of digital lending technology that automates the entire lending process from origination to underwriting to documentation. In fact, there are already a growing number of market challengers using this technology today, including LendingClub, Prosper and RocketLoans. And once they get a foothold into your account holder, your relationship is at risk.
Further, the CFPB and other regulatory bodies such as the OCC and NCUA have encouraged community financial institutions to offer better loan options to their consumers.6 The OCC, in a May 2018 statement, urged banks to offer products withay reasonable pricing and repayment terms to help meet the credit needs of their customers, while also imparting benefits from other bank services, such as financial education and credit reporting.”7
Additionally, in October 2017, the Consumer Financial Protection Bureau (CFPB) issued a new rule that would dramatically restrict lenders’ ability to profit from high-interest, short-term loans. While the CFPB may extend the date, payday lenders currently are required to comply with the rule by August 19 of this year. As currently written, the regulation could severely limit revenues of payday lenders by as much as 70 to 90 percent.8 This opens new opportunities for community banks and credit unions to step in and provide low-risk and affordable small-dollar loans.
Buy or Build the Technology?
As with any strategic initiative that relies on new technology, community financial institutions must assess their expertise and resources to determine whether they buy or build10 the solution. To build their own, institutions must be able to keep the technology updated and compliant, while also delivering a consistent and exceptional digital experience. The answer for most institutions is that building the technology is cost-prohibitive—not only operationally, but also from a staffing standpoint—and could take more time than the competitive market allows.
The alternative is to partner with a digital lending technology provider that offers a proven, cost-effective platform built with an emphasis on consumer protection, compliance and safety.
The Pew Charitable Trusts has led the charge on protecting consumers who need short-term, small dollar funding by putting forth a list of recommended safe loan standards.6 When assessing a technology solution, ensure your provider is open to adopting these guidelines on your behalf to ensure the loans are safe and affordable, including:
- Installment payments of no more than 5 percent of each paycheck or 6 percent of deposits into a checking account.
- Double-digit (not triple-digit) APRs that decline as loan sizes increase.
- Total costs that are no more than half of loan principal.
- Loan payments that cannot trigger overdraft or nonsufficient funds fees.
- Online or mobile application, with automated loan approval, so that loan funds can be quickly deposited into a borrower’s checking account.
- Credit bureau reporting of loan terms and repayment.
In addition to following Pew’s standards above, ensure your technology provider’s program offers:
- A fully-automated platform that requires no loan officer involvement. The entire digital loan application and approval process should be completed online in just a couple of minutes (think about a borrower in a checkout line), with borrowed funds deposited directly into the consumer’s account.
- Low charge-offs—the result of proven underwriting technology that assesses a customer’s ability to repay (no traditional credit check required), analyzes internal and external data sources, including deposit activity, and sets a maximum loan amount
- Compliance with all existing federal lending regulations including the Military Lending Act, and continuous monitoring of the regulatory landscape for any adjustments that may be necessary
- Loans automatically booked and funded to the institution’s core banking platform
- White label website and mobile app branded to the institution and integrated with the core and mobile banking via Single Sign On (SSO)
- Automatic deposit of loaned funds into the account holder’s account and scheduled repayment process
When surveyed, 81 percent of payday loan customers said they would prefer to borrow from their financial institutions if small-dollar installment loans were available there.9 Currently, however, very few financial institutions do so.
With the introduction of affordable and compliant loan automation software, community financial institutions can now offer these Americans low-risk, easy access to cash at affordable interest rates. Banks and credit unions can enjoy efficiencies of automating the entire loan process and avoid the high cost of individually underwriting and documenting short-term, small dollar loans, while providing their customers or members a much-needed valuable service.
1 https://www.theguardian.com/commentisfree/2018/jul/29/us-economy-workers-paycheck-robert-reich
2 https://www.forbes.com/sites/zackfriedman/2018/05/24/money-retirement-student-loans/#67d92f001059
3 https://files.consumerfinance.gov/f/documents/201708_cfpb_data-point_frequent-overdrafters.pdf
7 https://www.occ.gov/news-issuances/news-releases/2018/nr-occ-2018-51.html
8 https://www.americanbanker.com/news/cfpb-makes-it-official-changes-to-payday-rule-coming-in-new-year
10 https://www.bankdirector.com/index.php/issues/strategy/breaking-down-three-options-fintech/