By Sohrab Kohli, Senior Associate, Financial Health Network
Thursday in Kansas City, Missouri, the Consumer Financial Protection Bureau (CFPB) will be issuing a proposed rule on payday loans and other small-dollar loan products. This rule will likely introduce protections that would curb consumer harm and have other broad implications for much of the small-dollar credit (SDC) industry: payday lenders, auto title lenders, installment loan providers, and more.
There’s a lot of fog around this topic. Having conducted extensive research on small-dollar credit, here are 4 things lenders should understand about SDC borrowers and their needs:
1. There are four well-defined reasons people turn to small-dollar loans.
There is no one-size-fits-all solution for consumer credit needs. However, each of the 24 million SDC borrowers in America (“Member Exclusive Report from Financial Health Network’s Consumer Financial Health Study: The Financial Strains of Small-Dollar Credit Users”, Financial Health Network, March 2016) broadly fall into one of four primary need cases: unexpected expense, misaligned cash flow, exceeding income, or planned purchase. Underlying each of these need cases are specific implications and recommendations for providers seeking to better address these consumers’ financial health challenges. For instance, exceeding income borrowers typically access debt they cannot afford and are much more likely to fall into harmful cycles of debt. Providers should try to identify these consumers and offer them high-quality, safe solutions that help them improve their debt situation, rather than exacerbate it.
Know Your Borrower: The Four Needs Cases of Small-Dollar Credit Consumers
2. Customers have options.
There are a host of product structures out there, and increasingly customers have more options to choose from. As identified by our Small-Dollar Credit Test & Learn Working Group, it is important for lenders to offer borrowers high-quality choices, in terms of the products available to them, as well as flexibility or customization with those products. For example, online lender Enova, with its NetCredit product, found that when loan applicants can choose the size, length, and terms of their loans, take-up rates and successful repayments are likely to increase. Oportun, a California-based lender and CDFI, gives its borrowers the option to customize their payment schedule to best match their income cycle. This is another innovative model that ultimately helps support borrower repayment. Enova and Oportun are not alone in offering accommodating products to their customers — among the 16 industry leaders surveyed in Financial Health Network’s Snapshot of Quality and Innovation Among Small-Dollar Credit Installment Lenders, all 16 lenders offer customers some flexibility with choosing the amount or terms of their loan.
3. High-quality small-dollar credit should help consumers build credit history.
Unlike payday loans, high-quality credit products should help borrowers establish their credit scores and unlock better future credit opportunities. 11 of the 16 installment lenders surveyed for Financial Health Network’s Snapshot of Quality and Innovation Among Small-Dollar Credit Installment Lenders report borrower repayment history to the major credit bureaus. Well-designed, high-quality SDC products should also encourage borrowers to successfully make repayments and avoid late fees. Transparent marketing, disclosures and communications, matched with proactive support and guidance can ensure that a borrower has a successful credit experience. For example, Vancity, a Canadian credit union that offers the Fair & Fast Loan, will reach out to its customers who are struggling to repay their loans and will work to devise new payment plans that will help the borrower successfully repay their loan.
4. Big data is advancing ways to measure a borrower’s ability to repay.
There are at least 45 million Americans who are credit invisible (due to thin or non-existent credit files) or unscorable (Brevoort, Kenneth P. and Grimm, Phillip and Kambara, Michelle. “Data Point: Credit Invisibles”. The CFPB Office of Research. 2015). At least 10 million of these Americans would have a credit score over 600 if alternative data measures were incorporated in traditional scoring. With this in mind, it’s critical for lenders to try to reach as many potentially successful customers as possible, while still maintaining a cost effective and timely way to assess ability to repay. As the cost of data decreases and analytic methods accelerate, we hope to see more lenders incorporate big data to expand access and improve their financial health impact. To learn more about big data, check out Financial Health Network’s report Big Data, Big Potential: Harnessing Data Technology for the Underserved Market.
Real people need real access to credit, but they should also be covered by adequate consumer protections. Taking advantage of the inherent opportunity with the coming CFPB rules, we encourage lenders to reimagine and redesign SDC while keeping consumer needs in mind. This important research can help providers of all types — banks, credit unions, fintech providers, card companies — design higher-quality products in a way that helps consumers take steps toward achieving financial health.
By Financial Health Network on May 31, 2016.
