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Bad Credit People Risk Financial Security with Unsecured Personal Loan
Just as with any line of credit, the benefit of a cash advance, unsecured personal loan can be outweighed and pose a risk to financial security if not repaid timely.
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But often consumers place their personal finances at high risk by blindly agreeing to interest rates and fees, just so they can get quick approval and without first forcasting their ability to repay. In their hurried excitement to get cash to cover an emergency, pay bills, or for whatever reason, they fail to fully read and understand the terms, fees, rates, and how they will repay, or even if they can afford to repay. Maybe these personal loans should not have such easy approval in the first place?
Although they don't intend to do themselves financial harm, people generally find themselves in these bad situations by taking advantage of how easy some credit is to obtain and without regard to the costs. But the loans; and possibly the rates and fees, are not to blame. And though the high pressure of reassuring lenders may encourage people to borrow, it's not entirely their fault, either.
Mostly, people abuse credit because they want or need something, and they want or need it without first earning the necessary amount of money. Instead, they are so needy or eager, they are willing to pay to borrow money and to pay at a high cost if necessary. Case in point, short term cash advance loans. Why wait several months to earn the money needed, when a loan is available right now? So what if the loan is due in two weeks? Worry about it at that time.
People with a legitimate emergency cannot be fully blamed for abusing credit, particularly those with low income and who do not earn enough to adequately save money to cover such unexpected events.
If ever there is an occasion when a lender should be blamed, it's when the lender fails to clearly identify all rates and fees upfront, and doesn't explain what happens when repayment is late or if the loan is rolled-over. If those details are as clear as the loan itself, then lenders shouldn't be blamed for pushing high rate personal loans like cash advances. If a borrower enters the agreement and rolls-over the due date and extends the loan to a point where fees reach; or exceed, the principal loan amount, who's at fault? It could be argued that lenders are just doing their jobs of gaining customers, just the same as auto sales people.
Yet there are obvious problems with personal cash advance loans, as evident by some outright unscrupulous activities by some within the industry. For example, not helping a borrower fully understand that the loan is designed for a short period, and that over a long term the fees can pile up in excess of the original loan amount. And maybe when a customer is finally able to payoff a loan that has been rolled-over several times already, but the lender instead encourages the borrower to roll-over the loan yet again or to borrow more.
Consumers must also keep in mind, that a high risk loan not only means a high risk to the lender, but to the borrower as well.
Definition of High Risk Unsecured Loans, and who the lenders are and why there are few; if any, low interest unsecured loans with monthly installments.
They are called "High Risk Personal Loans" for a reason
Unsecured personal loans are among the highest risk subsets of subprime lending. These loans are typically small amounts for a short term repayment period, generally not large loans with monthly installments.
Some insured depository institutions have failed to properly assess and control the risks associated with their unsecured lending, to the point that these loan services can suffer defaults.
High risk unsecured loans; such as payday lending, are challenging for bankers and merit the continuing attention of depository institution supervisors.
What Are Unsecured Payday Loans? Payday loans are small-dollar, short-term, unsecured loans that borrowers promise to repay out of their next paycheck or regular income payment. Payday loans are usually priced at a fixed-dollar fee, which represents the finance charge to the borrower. Because these loans have such short terms to maturity, the cost of borrowing, expressed as an annual percentage rate, can range from 300 percent to 1,000 percent, or more. An example of a typical loan process for payday lending is described in the adjacent box.
How these no collateral loans Work: In return for the small loan - usually less than $500 (See Chart 1) - the borrower provides the lender with a check or debit authorization for the amount of the loan plus the finance charge. The lender agrees to defer presentment of the check until the customer's next payday. At the next payday, the customer may redeem the check by paying the loan amount plus the finance charge, or the lender may cash the check. In some cases, the borrower may extend the loan by paying only the finance charge and writing a new check.
Who uses these cash loans? Typically, payday customers have cash flow difficulties and few, if any, lower-cost borrowing alternatives. Payday customers tend to be frequent users of payday advances, often choosing either to "roll over" their credits or to obtain additional subsequent extensions of credit (See Chart 2). This data indicates that the cash flow difficulties experienced by many payday customers are a long-term credit characteristic as opposed to a short-term temporary hardship.
Payday Cash Borrowers Tend to be Repeat Customers: A study by the Credit Research Center at Georgetown University's McDonough School of Business indicates that payday customers often rely on payday loans because they have either been turned down for other forms of credit or offered less credit than the amount for which they had applied. The study also indicates that payday advance customers frequently have other characteristics associated with credit problems or limited credit availability, including borrowing from a pawnshop in the past five years, filing for bankruptcy in the past five years, or making payments 60 or more days late on a mortgage or consumer debt in the last year.1 As a result of these characteristics, payday lending is generally characterized as a form of subprime lending.
Who are Payday Lenders? At the beginning of the 1990s, payday lending was primarily the domain of smaller independent check cashing outlets and pawnshops that offered services related to check cashing. These firms specialized in making high-priced loans to borrowers with limited access to credit.
The number of payday lenders, however, has surged in recent years as more companies have been attracted by the higher fees earned on payday loans, as well as a high level of consumer demand for short-term, small denomination credit. New payday participants include large regional or national multi-service providers of payday loans, large regional or national monoline payday loan entities, and insured depository institutions. Although the number of known insured depository institutions involved in payday lending is small, third party payday lenders are actively seeking relationships with insured financial institutions.
Industry analysts estimate that the number of payday loan offices nationwide increased from less than 500 in the early 1990's to approximately 12,000 in 2002, with continued growth expected. The Community Financial Services Association of America, a trade group of the payday lending industry, estimated that payday lending activity in the United States during 2002 would reach about 180 million payday loans with a gross dollar volume of $45 billion.2
Insured Institutions and the Payday Market: Subprime lending in insured depository institutions is most commonly associated with auto, home equity, mortgage, and credit card lending. More recently, however, insured institutions have ventured into the payday lending arena.
Payday lending is not delineated in either bank Reports of Condition and Income or Thrift Financial Reports, but periodic surveys conducted by the FDIC indicate that relatively few insured depository institutions are currently involved in payday lending. However, there is no universal definition for payday lending, and some insured depository institutions have recently implemented overdraft lending programs that may, depending on the specifics of the program, exhibit characteristics similar to payday lending programs.
Insured depository institutions that are involved in payday lending have used various strategies to establish a presence in the market. Some have formed joint ventures with companies specializing in payday lending, while others have initiated payday lending programs internally. Insured institutions have extended loans directly to payday lenders, purchased payday loans from loan brokers, or lent to payday specialty lenders in the form of loan participations, warehouse lines, liquidity facilities, or dealer lines. While there is no evidence of an established asset-backed securities market for payday lending, some insured depository institutions have explored the possibility of securitizing and selling payday loans.
Risks Associated with Unsecured Loans: While the payday lending business presents banks with new growth opportunities, it also presents significant risks. To be sure, higher pricing on payday loans promises higher revenues and wider margins for lenders. However, there also are greater risks associated with payday lending. The credit risk associated with payday lending is significant, even when compared to other types of unsecured subprime lending such as credit card lending.
There are key differences between the underwriting methods used for subprime credit card lending and payday lending that renders payday lending among the highest risk subsets of subprime lending. Payday underwriting requirements are substantially less than those required by subprime credit card lenders who often supplement a prospective borrower's credit bureau report with such additional information as income, employment history, and the nature of prior credit problems. The prevailing underwriting criteria of most payday lenders require that consumers need proof only of a documented regular income stream, a personal checking account, and valid personal identification to receive a payday loan.
Credit quality data for specialty payday lending entities is lacking since most payday lenders are small, non-publicly traded firms. Review of publicly traded company reports indicates that some specialty payday lenders have recently recorded quarterly annualized net charge-off ratios as high as 83 percent,3 far higher than the typical annualized net charge-off ratio for subprime credit card lenders. Recent charge-off ratios for subprime lending institutions' credit card portfolios, while still high, typically do not exceed 20 percent. Higher default rates for payday loan portfolios indicate that loan loss reserves and capital levels that may be adequate for some other forms of subprime lending may not properly cover the greater risks associated with payday loans.
Depository institutions involved in payday lending also may enter arrangements with third parties to originate payday loans. These loans often involve fees and charges in excess of those the third party could otherwise charge under state law. Although federal banking statutes authorize insured depository institutions to "export" interest rates from states where the lender is located on loans made to borrowers residing outside the state, litigation involving the use of this authority by third-party payday lenders has recently increased. In addition, some suits also have alleged lender violations of various state and federal consumer protection laws in connection with these loans. Thus, participation in these arrangements may expose insured depository institutions to substantial legal and reputational risks. In addition, third-party arrangements may also pose additional operational risks, such as a heightened risk of transactional error or fraud.
Payday lending presents insured depository institutions with significant risks. To be successful in payday lending, depository institutions must adequately identify, measure, monitor, and control the attendant risks. Depository institutions also must ensure that adequate management expertise and the appropriate level of capitalization are available, as well as programs that ensure compliance with consumer protection laws. Conversely, deficiencies in assessing and controlling the risks of payday lending can have serious consequences. Such deficiencies have surfaced at a number of insured institutions.
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