Installment loans appear to be a softer, softer version of their “predatory” cousin, the payday loan. But for consumers, they can be even more harmful.
The use of installment loans, in which a consumer borrows a lump sum and pays back principal and interest in a series of regular payments, has increased significantly since 2013, as regulators began to curb payday lending. In fact, payday lenders seem to have developed installment loans primarily to escape this increased scrutiny.
A closer look at the differences between the two types of loans shows why we think the growth of installment loans is of concern – and requires the same regulatory attention as payday loans.
At first glance, it seems that installment loans might be less harmful than payday loans. They tend to be bigger, can be repaid over longer periods of time, and generally have lower annualized interest rates – all potentially good things.
While payday loans are generally around US $ 350, installment loans tend to be between $ 500 and $ 2,000. The ability to borrow more can benefit consumers with greater short-term needs. Since installment loans are repaid in bi-weekly or monthly installments over a period of six to nine months, lenders say consumers are better able to handle the financial pressure that brought them to their storefront in the first place. .
Payday loans, on the other hand, typically require a lump sum payment for interest and principal on the borrower’s very next payment date, often within a few days. Lenders offer cash in exchange for a post-dated check drawn on the borrower’s checking account for the amount borrowed and “fees” – what they often call “interest” to get around the rules of usury.
Finally, and perhaps most importantly, installment loans are often less expensive than payday loans, with annualized interest rates of around 120% in some states, compared to the typical range of 400% to 500% payday loans.
Harmful to consumers
Unfortunately, some of the structural features that seem beneficial can actually be detrimental to consumers – and make them even worse than payday loans. For example, the longer repayment period keeps borrowers in debt longer and requires sustained discipline to make repayments, which can increase stress and the possibility of error. And the fact that the loan amounts are larger can work both ways.
It is true that the small amount of payday loans is often not enough to cover the immediate needs of a borrower. About 80% of payday borrowers do not repay their loan in full when due, but “renew” their loan in a subsequent paycheck. Renewing a loan allows borrowers to pay only interest and then extend the loan in exchange for another payroll cycle to pay off at the cost of another interest payment.
In a recent study, we explored the effect of larger installment loans on borrowers. We used a dataset with thousands of installment loan records in which some borrowers received a larger loan because they were earning more income. Although similar in terms of factors such as credit risk and income level, slightly higher income borrowers were offered a loan of $ 900, while others were given only $ 600.
We found that borrowers with these larger loans were more likely to subsequently incur debt on other installment loans, in-store and online payday loans, and auto title loans. Our results suggest that the higher initial installment loan may not serve its primary purpose of helping borrowers manage their finances and may in fact have caused increased financial pressure.
Abuse and abuse
As some of our previous research has shown, even payday loans, with their annualized rates and very high lump sum payments, can be beneficial to consumers in some cases. Installment loans are no different. When used with care, they can help low-income consumers with no other credit access smooth consumption. And when they are repaid on time, loans can certainly provide a net benefit.
But their nature means that they are also subject to abuse and abuse. And any negative effects will apply to a larger group of consumers, as they are considered more “generalist” than payday loans. Lenders target consumers with higher credit scores and incomes than “fringe” borrowers who tend to use payday loans.
Installment loans represent an increasingly important part of the alternative credit sector. If the regulatory crackdown on payday loans continues, installment loans are likely to become the bulk of loans in the low-interest, high-interest loan market. Given the current lack of regulation of these types of loans, we hope they will receive further consideration.