I have a friend who has a brother with a problem.
Every other month or so, he receives a call or a message. His brother needs cash. Right away. He won’t be able to pay his rent without it.
He always promises to pay his brother back—as soon as the next commission payment hits the checking account—and usually manages to keep his word. There’s never a discussion about interest or even covering the wire fee because, well, that’s what brothers are for, right?
The problem isn’t that my friend’s brother is unlucky. It’s that his budget is so tight that when the two of them first agreed to head down this perilous path, the brother ended up digging a cash-flow hole he was never going to be able to fill.
The scenario goes to the heart of the matter with regard to payday, bill-pay and other forms of short-term financing. The collateral typically takes the form of a future paycheck that is either diverted to the lender or extracted from a checking account upon its deposit, or a reasonable assurance of continued employment. That the borrower is living from pay period to pay period is of less concern than the value and reliability of that every-other-week deposit.
Even so, the loan products are breathtakingly expensive for a consumer: Interest and fees can easily exceed the value of the financed amount, given the number of times the same money is re-borrowed.
There are a couple of reasons for that. First, without the lender charging a hefty price, there’s only so much it can earn from a small loan that’s outstanding for so short a period, relatively speaking. Second, these and other alternative financing products are today’s darlings of the investment community, not least because of the outsized profits they produce—profits that the finance companies’ backers expect will continue.
So while the Consumer Financial Protection Bureau is busily engaged in developing rules that are intended to rein in certain egregious practices that make payday, bill-pay and auto-title loans detrimental to borrowers’ health, I’m actually more encouraged by the news that some other members of the alternative finance community are working on ways to help this struggling consumer demographic.
According to the Wall Street Journal, Lending Club, an online social lending platform that matches consumer-borrowers with consumer-investors, has cut a deal with BankAlliance—a consortium of 200 community banks—to sell blocks of small-balance loans (less than $35,000) to the consortium’s members.
Two things make this arrangement promising.
The loans that are originated on Lending Club’s site are unsecured: There are no payroll checks to intercept or checking accounts to invade. Instead, the banks that choose to participate in this program also agree to rely on Lending Club’s credit-underwriting methodology, a process that somewhat resembles what the CFPB has in mind for payday and other short-term lenders. The fact that these loans are also purchased in bulk helps to spread losses over a large population of individual borrowers.
As important, this scheme has the potential to transition a group of heretofore underbanked and underserved consumers into the less costly world (relatively speaking) of traditional finance.
But until this concept takes hold, the CFPB would do well to oversee all short-term consumer lending activities on a national level. Otherwise, unscrupulous finance companies will continue to shop for accommodating jurisdictions in which to set up shop and pitch their products in potentially misleading ways.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
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