Published: November 2023
Source: Federal Reserve Bank of New York
Why we picked it: Fintech, the internet, market-based lenders (formerly called “P2P lenders”), and renewed interest in unsecured personal loans all converged in the 2000s to completely reinvent the personal credit business. Once the province of consumer finance companies and credit unions, unsecured personal loans became a more viable option for many more people. Two factors — 24/7 availability online and the adoption of alternative credit criteria — opened this credit channel to more consumers. The fintech drivers of this business impacted banking directly when LendingClub and SoFi acquired banks.
The classic, and still dominant, use of unsecured personal loans has been debt consolidation, chiefly credit card debt. Now that U.S. consumer credit card debt has topped $1 trillion, this channel is even more important to watch.
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The New York Federal Reserve Bank’s Community Development team, which has been studying issues concerning low- and moderate-income consumers, produced the report. A key reason is those consumers’ frequent need for affordable and available credit.
For many years, low- and moderate-income borrowers depended on less-attractive credit alternatives, including payday loans and the heavy use of overdrafts. Small personal loans from the banking industry had been scarce for years, as many institutions stopped making them, citing the high costs for low returns.
The advent of fintech-driven unsecured lending presented these consumers with a more palatable option.
“More palatable” credit isn’t necessarily ideal. “In many cases, [low- and moderate-income] borrowers still face issues with the general affordability of fintech loans,” the report says. “While fintech loans generally have substantially lower APRs than payday loan products, there is still a risk that the rates offered can remain very high.” The report cites research indicating that some borrowers who have tapped loans offered by fintech-bank partnerships are being charged more than their state’s usury law limits permit. (The Financial Brand has heard from industry sources that there’s a growing number of states challenging such partnerships, focusing on the use of national bank charters to evade state rate ceilings.)
“Ideal” is becoming scarcer while demand remains strong. The costs of unsecured fintech personal loans are rising and standards are tighter. Delinquencies have risen. But the desire for these loans among low- and moderate-income consumers continues to grow. They want help with rising costs and with expensive and growing credit card balances, according to the report.
Quotable: “In the high interest rate environment of 2022-2023, some fintech lenders that aim to reach underserved populations have opted to originate fewer unsecured personal loans to these populations, due to the cost of capital, and shift to other non-credit business lines and product types.”
• Unsecured personal loans in the U.S. totaled $232 billion in September 2023, according to TransUnion data cited by the N.Y. Fed. That’s nearly 122% more than in 2017. The volume dipped during the height of the pandemic, thanks to various relief programs, but growth returned in the second part of 2021. Overall, between 2017 and 2023 period, people were borrowing more and more people were borrowing: the absolute number of personal loans rose by almost 26%.
• Fintechs have gone in and out of personal loans. In 2022 and 2023, economic conditions and increasing cost of capital caused these lenders to tighten up. In September 2023, their share of originations of unsecured personal credit, by number of new loans, fell to 26.5%. That’s down more than ten percentage points from 37.7% the previous year.
• “Classic” use of unsecured personal loans continues. Figures from Prosper Marketplace, a marketplace lender, used in the analysis, indicate that among all income categories refinancing high, variable-rate credit card debt and other bills into fixed-rate personal loans is still the leading use case.
What we liked: Pulling together the ups and downs and ins and outs of unsecured personal loans over an incredibly choppy economic period helped us better understand what’s gone on. Reading the history of fintech involvement was a bit of a whiplash experience — fintech lending up, down, back up! — but it’s a subset of times that deserve deep focus by all lenders.
What we didn’t: Focusing solely on fintech personal loans for these economic groups just doesn’t seem to cover the whole waterfront. The trend toward more and more credit builder products is barely touched on. The growing influence of buy now, pay later credit isn’t covered, although that may be due to a lack of reporting to credit bureaus.
Case in point: Statistics from Affirm cited in a recent article on The Financial Brand,.indicate that the bulk of dollars paid through its Affirm Card go to interest-bearing, longer-term plans. The company says this is because many purchases are for high ticket items.
Things that made us go “Hmm”: Citing Prosper data, the report says that “the share of unsecured personal loans used for debt consolidation by those in the below $25,000 income category increased to 66%.”
Confession: Research that frequently shows consumers relying on credit cards “to make ends meet” should make us all cringe.
Ever since a LendingClub official made the case that periodically refinancing credit card debt made debt consolidation loans a “financial health tool,” we’ve wondered if a scissor applied to a couple of cards might work better.
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How Consumers Are Using Unsecured Personal Loans
In 2022, here’s how three income groups indicated they were using loan proceeds. A few definitions: “Household” covers repairs, home improvements and family needs; “Health” covers medical and dental costs; and “Other” includes vacation, taxes and miscellaneous expenses.
- Below $25,000: Debt consolidation, 51%; Household, 22%; Health, 4%; and Other, 24%.
- $25,000-$50,000: Debt consolidation, 62%; Household, 19%; Health, 3%; and Other, 16%.
- All Income Tiers: Debt consolidation, 64%; Household, 21%; Health, 3%; and Other, 12%.
Given how routinely this tool is relied on for debt relief, an interesting footnote is worth magnifying to readable size:
“Some research also suggests that debt consolidation may exacerbate debt distress if these loans add to the overall cost of credit — in the most recent high interest rate environment of 2022-23, this might become a more relevant concern for low- and moderate-income borrowers with debt consolidation burdens.” [Emphasis added.]
The report digs into average loan size as a share of annual income, by tier. Among households earning below $25,000, this percentage has been rising, from 27% of annual income in 2017 to 40% in 2022. Contrast this with the other two income tiers examined. Among people with annual income between $25,000-$50,000, the percentage fell from 25% in 2017 to 20% in 2022. The measure also dropped among consumers with annual incomes of $75,000-$100,000, from 18% to 15%.
Regarding the trend among the under $25,000 group, the report observed that it was an indication that “there are growing credit needs for this category given the rising costs of living and borrowing.”
But it also raises this question: Are the loan options being offered by fintech lenders affordable, particularly in comparison to credit cards and other types of debt?
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Delving into Medical Loans
In addition to the data above, the report finds that among the under-$25,000 income group unsecured personal loans used for medical costs peaked at 7% of the total number of these loans to that group. in 2021.
The report suggests that “borrowers in this income category have an acute need for credit to finance higher and unexpected health expenses, particularly in the wake of the pandemic.”
The two primary channels for such loans are either: directly with lenders or through physicians and other health providers, who offer third-party financing for certain procedures. (This has been an area of expansion for installment financing companies as well as some specialized credit cards, building on homemade installment plans that some providers have offered historically.)
Lenders will advance funds for elective treatments, like fertility treatments, as well as elective procedures, such as cosmetic surgery and dentistry, bariatric surgery, hair restoration and more. There’s also financing available for major pharmacy spending, hospital costs and ambulance charges. Among the types of services sites mention, Prosper’s own includes financing for mental and behavioral treatment: “Finding the right mental health care can be challenging. The last thing you need is any additional worry about how to pay for it.”
Flexible terms, fixed rates and quick decisions are three points commonly used to promote these loans.
Extra Credit: Another Side of Alternative Data and Underwriting
Use of alternative data — information not reflected in standard credit reports and typically not included in credit decisions — often gets spoken of as a panacea for people with thin or nonexistent credit files. But this report cautions that “more clarity is needed around how to regulate the use of alternative data under the existing consumer protection framework (i.e., Equal Credit Opportunity Act, Fair Credit Reporting Act).” Worth watching.