How Installment Loan Borrowers are Affected by State Laws. 

Borrowing money is quite a common practice for Americans and when they need to do it the majority prefers using credit cards or taking loans from credit unions or banks. Financing from manufacturers or retailers can also be a rather good variant. For those people who can’t boast a very good credit history or high credit scores there is an option just to borrow a necessary amount taking a payday loan or using services of auto title lenders. Nevertheless, it’s worth mentioning that the latest option has been widely studied by regulatory bodies which has imposed some restrictions on their activity in course of the past few years.

But speaking about the nonbank consumer credit market it’s impossible to omit such a segment as Installment Loans. Though they haven’t been studied in a proper way yet, every year more than 10 mln Americans use them and an impressive amount of over $10 bln is spent annually on interest and fees. The amounts borrowed may vary: from $100 to over $10,000, as well as the purposes of those who take these loans.

Today loans are available at approximately 14,000 stores located in 44 US states. The largest lender has a much wider network than any bank in the US and has access to at least 87% of the country’s population.

While installment loans have already gained an enormous popularity in the US, they are still not fully regulated which may make them look not very reliable for some consumers. However, according to the experts of the Pew Charitable Trusts, there are no reasons to worry about1. Installment loans represent themselves a much more affordable and significantly safer (which is extremely important!) alternative to Payday Loans or auto title loans which are also rather popular today.

The problem is that at the current moment there are no state laws that can really secure customers from financial risks and prevent destructive lending practices that may affect the interests of borrowers. There isn’t any protection for customers from front-loaded origination and acquisition fees which makes a total cost of the loan disproportionately high.

Though in some cases refinancing may bring benefits, upfront and front-loading fees can really deteriorate the situation.

Origination fees that are nonrefundable is a good thing for lenders, nevertheless, if we look at them from the consumers’ perspective, it’s obvious that the first months when the fees are charged are the most difficult for them. Though it could be fairer to spread these fees over the entire loan period, a number of state laws not only permit but even support this practice.

Due to front-loaded fees a lot of consumers need to turn to refinancing of their loans which brings even more profit to lenders. According to statistical data, annually 75% of loans are consecutively refinanced, as a result the cost of borrowing is continuously increasing, especially if each time when you refinance your loan you need to pay origination and upfront fees again and again.

Credit insurance and other ancillary premiums may cause a growth not only of the amount borrowed but also the amount of interest that the lender gets. This amount which is formed on the base of costs of all these products is not included in a loan agreement and is not taken into consideration when a stated annual percentage rate (APR) is being calculated. As a result, a borrower need to pay a much higher APR than it was supposed initially.

Such an approach makes it possible for lenders to comply with state interest-rate caps. While officially stated APRs may meet all regulatory requirements, real APRs may significantly exceed them. Moreover, this practice can absolutely mislead consumers as they never know final figures while they are choosing credit products and analyzing different variants.

These situations are quite widespread in states where there are some official requirements related to interest rates but where sale of credit insurance and other additional products for loans is permitted.

According to the results of Pew’s research, in cases when the government imposes rate limits lenders try to find other ways to get higher profits from loans. As a result, they start selling credit insurance to generate revenue that they can’t get from fees or interest anymore. In one fiscal year, over $450 mln was reported as combined revenue from ancillary products received by 5 major installment lenders in the US.

To improve the situation for consumers and ensure better protection for them, it is necessary to introduce some changes in this sphere as it is highly important to take into consideration not only the interest of lenders but of borrowers as well.

What should be changed:

  • Costs and fees should be spread evenly all over the loan period.
  • Origination fees should be proportional to the amount borrowed and refundable. In such a case lenders won’t be interested in loans refinancing and borrowers won’t lose their money.
  • Credit insurance should function in accordance with standard insurance policies.
  • There should be normal loss ratios and premiums should be paid monthly.
  • Sale of insurance ancillary products should be carried out separately from the issuance of loan.
  • Credit insurance as well as additional products should be sold after the loan agreement is approved.
  • Transparency and openness should be increased.

To make installment loans safer for consumers, it is unnecessary to make rates lower, in such a case lenders will try to earn money from selling ancillary products that are not really needed. It’s better to make rates comparatively high to allow lenders to get their profit honestly

These changes would make installment loans much safer and more affordable for customers and at the same time they wouldn’t violate the rights of lenders as well. In general, it’s really vital for the industry to find the balance between the interests of those who borrow money and who lend them.