Pew report: State laws put installment loan borrowers at risk
WASHINGTON—Major weaknesses in state laws have led to practices that obscure the true cost of small installment loans, discourage safer loans and hurt customers, according to a new report from The Pew Charitable Trusts, “State Laws Put Tempo Loan Borrowers at Risk. ”
About 10 million Americans use installment loans each year, spending over $10 billion in fees and interest to borrow amounts ranging from $100 to over $10,000. The loans are issued at about 14,000 stores in 44 states by consumer finance companies, which differ from lenders who provide payday loans and auto title loans, and have prices far below those of those products. The loans are repaid in four to 60 monthly installments which are generally affordable for borrowers.
This segment of the small credit market had not been well studied until now, and the Pew report notes that the pricing, affordability and structure of installment loans are more favorable to consumers than those of other products. subprime credit, such as payday loans and auto titles. loans. However, the study also finds that state regulatory frameworks permit and often encourage three consumer-damaging practices: up-front fees, reported annual percentage rates that do not reflect full loan costs plus ancillary products, and selling credit insurance and other low value products with upfront premiums.
“Many state laws lead to unsafe lending practices that expose borrowers to unnecessary financial risk,” said Nick Bourke, director of Pew’s Consumer Lending Project. “With reasonable collateral, installment loans can be better alternatives to payday loans and other high-cost loans for borrowers with low credit scores.”
Pew recommends that lenders, legislators and regulators improve outcomes for consumers who use installment loans by:
- Spread the costs evenly over the life of the loan. Origination or acquisition fees should be nominal, proportional to the amount financed, and repayable on a pro rata basis to minimize lenders’ incentives to refinance loans and avoid harming borrowers.
- Require credit insurance to work like other standard insurance policieswith typical loss ratios and monthly premiums rather than pre-billed and funded premiums.
- Mandate that the sale of ancillary products be separated from the issuance of credit. Credit insurance and non-loan products should only be offered after the loan transaction has been completed and the borrower has either received the product or been notified that the loan has been approved.
- Establish or continue to establish transparent maximum allowable costs that are fair to borrowers and viable for lenders. If policymakers want modest installment loans to be available and safe for consumers, they should allow interest rates high enough to allow efficient lenders to operate profitably and ban ancillary products rather than setting lower rates and then allow lenders to sell ancillary products to increase their bottom lines. Existing research is mixed on the overall impact of small credit on consumer welfare, so policymakers can—as those in some states have already done—effectively prohibit small credit by setting limits on low rates and prohibiting fees and ancillary products.
These improvements to state laws would allow installment loans to evolve into safer and more affordable alternatives to other non-bank credit and better serve customers who have few good options today.
The Pew Charitable Trusts is driven by the power of knowledge to solve today’s toughest problems. Learn more about pewtrusts.org.