Can Credit Unions Replace "Predatory" Lending?

Felix Salmon has a really interesting piece about a professor who took out a loan from a personal finance company–at a roughly 40% APR–after her credit union turned her away.

Is it a good idea for the professor to be taking out loans at 40% interest rates? Really, she didn’t have much of a choice. She needed the money, she got precious little help from her credit union, and the loan company was friendly and extended her the cash on terms she could afford.
What’s more, the professor’s relationship with World Finance has indeed improved her credit. Since taking out that first loan, she’s obtained two different credit cards, and also bought a brand-new BMW with 2.9% financing. All with essentially no help at all from her primary financial institution, which is Missouri Credit Union. The debt the professor is taking on may or may not be wise, given her unique individual circumstances. And the credit union could in theory be a valuable resource in terms of helping her work out whether, for instance, she can really afford that car. But the relationship there is broken, and I see no chance that it will be fixed.
James does admit that he let the professor down: “I think we did fail her,” he says, “and I don’t think we did what we should have done.” The credit union dropped the ball with respect to her loan application, which was left in limbo when she was in a time of need. But at the same time, he also admitted to me that the credit union would not have given her the unsecured loan she was looking for.
The professor’s credit score is now good enough that she qualifies for a mortgage; it wasn’t before. That’s the kind of help a credit union should be able to give, and it’s disappointing that Missouri Credit Union doesn’t seem to be able to bring itself to do that. If the professor (a) wanted credit and (b) wanted to improve her credit score, then the loan company was, sadly, the place she needed to go.

Salmon, who is an enormous booster of credit unions, thinks that this points to directions for reform:

So two things are needed here, I think. The first is effective regulation, with teeth; I hope that Richard Cordray, newly installed at the head of the CFPB, will start providing that soon. There’s no time to waste.
But regulation isn’t enough: we also need alternatives — non-predatory financial products which allow people with bad credit to repair that credit and get back on their feet. Many credit unions provide such products, but as we’ve seen, many credit unions don’t. And credit unions are in any case often difficult institutions to navigate: it’s never entirely obvious who’s allowed to join any given one. Can someone set up a Kiva for America? Help is needed, here. And it’s very hard to find.

I too, am a fan of the credit union. We got our mortgage through Navy Federal, and even though we could probably refinance to something cheaper, we’re sticking with them because I like the customer service and the fact that they will bend over backwards to fix issues with your loan.  (Back when I had a car loan, it took me a year to straighten out issues with my car titling, and as long as I made the payments, they kept giving me more time).

But I don’t think that they are somehow going to substitute for the lenders at the bottom of the risk market: loan companies and payday lenders.  Felix, who is on the board of a credit union, may have some insight into this that I don’t, of course.  But right now, I don’t see it.

Credit unions are not charities.  They have responsibilities to the members who deposit money with them: they cannot make loans that are reasonably likely to lose money (at least in aggregate).  And while the interest rates on products like payday loans are indeed eye-popping, the companies themselves are not especially profitable.  This suggests that the reason the loans are so expensive is that they cost a lot to make.

Why is this?  For starters, because the risk of default is very high.  It’s hard to get good numbers, and estimates vary widely, but I’m pretty sure that they’re well north of 10%.  That’s a pretty high default rate for any type of loan, but particularly one where the term is measured in weeks.
That’s not the only reason to think that these loans are expensive.  Since they are often for very small amounts, they have high transaction costs relative to the loan amount–it takes just as much time to process forms for a $200 loan as it does for a $10,000 loan.
There’s also the structure of the loan, which involves a lot of intensive interaction with the borrower.  Remember, the short term (and the fact that they’re tied to payday) helps hold down the default costs on payday loans.  It’s also really expensive to achieve; it means maintaining a storefront with people in it at all hours.
Credit unions might make those loans somewhat cheaper by layering that overhead on top of existing operations, and because they don’t need to make a profit.  On the other hand, credit unions lack expertise and skill in this sort of loan.  In general, credit union loans are not wildly cheaper than similar loans from other institutions.
But I suspect that what Felix has in mind is substituting a different–and much cheaper–type of loan for the payday loans.  And I’m skeptical that this can happen.  All of the research that I’ve seen on these super-expensive loan products indicates that most of the people who are taking them are not doing so because they don’t understand how high the interest rate is, but rather, because they have exhausted all of their other borrowing options.  (And frequently, the alternative is even more expensive: a bounced check fee, a utility disconnect that will require a hefty fee for reconnection, a lost day of work because of car trouble).
So I take it that the reason that the credit unions aren’t putting them into cheaper loans is that they can’t.  The cost of an unsecured loan to someone with terrible credit is high because those loans go bad very frequently, resulting not only in the loss of funds, but in considerable overhead expended on collection.  Particularly in the case of credit unions, who–as my auto loan illustrates–work very, very hard to keep their members’ loans from going bad.
And I’d guess that credit unions, for all sorts of reasons, don’t really want to get into the super-expensive-super-risky loan business.  That’s why they focus on figuring out how to help you not need the money.  Obviously, that is going to be a bad outcome in some particular cases, because no system is ever perfect.  But on balance, I can understand why credit unions aren’t eager to get into the payday loan game.

Update:  Apparently, some are.  But the products often aren’t substantially cheaper than regular payday loans–though Felix highlights this program at a State Employees credit union, which does look much cheaper.

Felix asks me if there’s any reason that last program can’t scale.  I think there are three possibilities:
1.  They’re losing money on it, and a lot of credit unions can’t be in the business of charity to people who need payday loans
2.  Their lending population is somehow different from those who need regular payday loans (state paychecks are pretty steady, and the program requires direct deposit)
3.  It’s a game changer that will revolutionize payday loans.
I’m pretty skeptical that #3 is the answer–these loans are cheaper than most credit cards, and that’s a very competitive space.  On the other hand, all game changing innovations suffer from not having been done before: that’s no proof that they can’t be.  I’ll only note that the general experience of nonprofits in this space seems to be that they have to charge high APRs (or fees that amount to the same thing) in order to make up for the costs.
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Financial advice extends beyond planning

There is a flurry of activity in the financial planning and advisory space. The practice of earning a commission from the producer is on its way out and several advisers are designing value propositions to earn a fee from the customer. Most financial advisers like the idea of financial goals, their estimation, and investment products designed to get there. Advisory is quickly getting equated to planning, but it should ideally cover a much larger ground.
There is no denying that the clientele for personal financial services is growing. While most open a bank account as soon as they begin to earn, they do not get dependable advice on how to manage their finances after that. Even opening a bank account has now become a matter of advice, with free pricing of deposits and services. Customers need advice on taking loans, managing their liquidity, making and monitoring their investments and ensuring that their wealth is taken good care of. Let me spell out some simple advisory services that customers may be looking for.
First, investors may need help with management of investible surplus. While it makes perfect sense to deploy the surplus, the activities associated with its deployment take time, energy and paperwork, which many of us shun. Advisers working with banks, who have access to investors’ balances, can help in routinely investing this surplus. However, they tend to not do so since it helps their bank to have these low-cost funds lying around unused. Non-bank advisers can step in to see if they can put a process in place, converting routine surpluses to deposits, bonds, or investments in saving schemes. A large number of people will heave a sigh of relief at this possibility.
Second, while motor vehicle insurance is easily done, other forms of insurance are not seen as tools to managing expenses better. Low wage earners, such as drivers and maids, may need health insurance, and there may be generous employers willing to pay the premium, only if an adviser arranges the process and paperwork. Several need general insurance to protect their assets, but may not have the time to complete the tasks that lead to the purchase of an appropriate policy. Then there are people who change their jobs often, but don’t care to check how well they are covered by health insurance. There are others who do not work for employers who provide such a cover. Several may need health plans that protect them and their families adequately. Beyond the greed for Ulip and the plain vanilla term policy, possibilities in insurance remain mostly untapped.
Third, there is the general view that financial advisory services are for the high net worth individuals (HNIs). Nothing can be far from truth, but there are several advisers who do not find it worthwhile to acquire and nurture a large number of small value clients. There is also a clamour for ‘expert’, ‘customised’ or ‘exclusive’, the fancy sales lingo describing financial services that restricts the number of clients an adviser can service. There is a large population requiring far simpler stuff. These can become standardised services, which can be scaled up across a large number of clients. Strangely, this is still not attempted, even by large banks with a huge retail base. Customers may be keen to have their net worth computed, their portfolios listed, their holdings valued, their loans consolidated, their defunct PPF and post office accounts closed, their paper shares dematerialised, their bond redemption reclaimed. A hundred simple services await adviser attention if they cared to look.
Fourth, not all financial advisory is about products, markets and asset allocation. Consider paperwork. Investors need serious help with their holdings, typically kept in multiple names and combinations, in multiple folios, and various stages of completion of formalities of nomination, automation and consolidation. Not everyone is a process expert and some of us can procrastinate endlessly about putting our papers in order. In fact, most would be willing to pay a fee if someone cleaned it all up. Most investors understand the need to have the family’s wealth accessible and listed in good order, so that there is no crisis if there’s a mishap. But there is no reliable adviser service, which can help organise the wealth meaningfully, so it can be used for the purpose for which it was created. Wills and trusts are still in the realm of the exotic, while many families struggle to put the house in order when someone dies without an accessible record of investments and how it can be used. Ensuring business as usual for a family that faces a crisis is as valuable a service as a business process back-up that uses sophisticated technological tools. Advisers do not seem to have taken cognisance of the need for robust processes for their customers.
Fifth, investors need advice not just for buying investment products and reaching financial goals, but for strategic financial choices. They may need advice on managing their erratic income, as can be the case for sporting professionals, media and film professionals, or other self-employed people. They may like to see how their choices in the future about earning and spending will pan out, and how to organise themselves. They may need advice on borrowing, managing credit, funding small businesses using investments, protection from bankruptcy, and restructuring loans and assets. Where a choice about personal finance has to be made, there may be a need for advice. One hopes that financial advisers will move from merely estimating retirement corpus and suggesting SIPs.
–Uma Shashikant The author is Managing Director, Centre for Investment Education and Learning, and can be reached at uma.shashikant@ ciel.co.in

http://tourism9.com/

Financial advice extends beyond planning

There is a flurry of activity in the financial planning and advisory space. The practice of earning a commission from the producer is on its way out and several advisers are designing value propositions to earn a fee from the customer. Most financial advisers like the idea of financial goals, their estimation, and investment products designed to get there. Advisory is quickly getting equated to planning, but it should ideally cover a much larger ground.
There is no denying that the clientele for personal financial services is growing. While most open a bank account as soon as they begin to earn, they do not get dependable advice on how to manage their finances after that. Even opening a bank account has now become a matter of advice, with free pricing of deposits and services. Customers need advice on taking loans, managing their liquidity, making and monitoring their investments and ensuring that their wealth is taken good care of. Let me spell out some simple advisory services that customers may be looking for.
First, investors may need help with management of investible surplus. While it makes perfect sense to deploy the surplus, the activities associated with its deployment take time, energy and paperwork, which many of us shun. Advisers working with banks, who have access to investors’ balances, can help in routinely investing this surplus. However, they tend to not do so since it helps their bank to have these low-cost funds lying around unused. Non-bank advisers can step in to see if they can put a process in place, converting routine surpluses to deposits, bonds, or investments in saving schemes. A large number of people will heave a sigh of relief at this possibility.
Second, while motor vehicle insurance is easily done, other forms of insurance are not seen as tools to managing expenses better. Low wage earners, such as drivers and maids, may need health insurance, and there may be generous employers willing to pay the premium, only if an adviser arranges the process and paperwork. Several need general insurance to protect their assets, but may not have the time to complete the tasks that lead to the purchase of an appropriate policy. Then there are people who change their jobs often, but don’t care to check how well they are covered by health insurance. There are others who do not work for employers who provide such a cover. Several may need health plans that protect them and their families adequately. Beyond the greed for Ulip and the plain vanilla term policy, possibilities in insurance remain mostly untapped.
Third, there is the general view that financial advisory services are for the high net worth individuals (HNIs). Nothing can be far from truth, but there are several advisers who do not find it worthwhile to acquire and nurture a large number of small value clients. There is also a clamour for ‘expert’, ‘customised’ or ‘exclusive’, the fancy sales lingo describing financial services that restricts the number of clients an adviser can service. There is a large population requiring far simpler stuff. These can become standardised services, which can be scaled up across a large number of clients. Strangely, this is still not attempted, even by large banks with a huge retail base. Customers may be keen to have their net worth computed, their portfolios listed, their holdings valued, their loans consolidated, their defunct PPF and post office accounts closed, their paper shares dematerialised, their bond redemption reclaimed. A hundred simple services await adviser attention if they cared to look.
Fourth, not all financial advisory is about products, markets and asset allocation. Consider paperwork. Investors need serious help with their holdings, typically kept in multiple names and combinations, in multiple folios, and various stages of completion of formalities of nomination, automation and consolidation. Not everyone is a process expert and some of us can procrastinate endlessly about putting our papers in order. In fact, most would be willing to pay a fee if someone cleaned it all up. Most investors understand the need to have the family’s wealth accessible and listed in good order, so that there is no crisis if there’s a mishap. But there is no reliable adviser service, which can help organise the wealth meaningfully, so it can be used for the purpose for which it was created. Wills and trusts are still in the realm of the exotic, while many families struggle to put the house in order when someone dies without an accessible record of investments and how it can be used. Ensuring business as usual for a family that faces a crisis is as valuable a service as a business process back-up that uses sophisticated technological tools. Advisers do not seem to have taken cognisance of the need for robust processes for their customers.
Fifth, investors need advice not just for buying investment products and reaching financial goals, but for strategic financial choices. They may need advice on managing their erratic income, as can be the case for sporting professionals, media and film professionals, or other self-employed people. They may like to see how their choices in the future about earning and spending will pan out, and how to organise themselves. They may need advice on borrowing, managing credit, funding small businesses using investments, protection from bankruptcy, and restructuring loans and assets. Where a choice about personal finance has to be made, there may be a need for advice. One hopes that financial advisers will move from merely estimating retirement corpus and suggesting SIPs.
–Uma Shashikant The author is Managing Director, Centre for Investment Education and Learning, and can be reached at uma.shashikant@ ciel.co.in

http://tourism9.com/