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Payday loans have been the subject of much debate in recent years, and that debate was partly triggered by the publication of a report by the Consumer Financial Protection Bureau that labelled the short term loans "a long-term, expensive debt burden". There is, however, another type of short-term loan that is growing in popularity that is also targeted at the low-income earners in the US, in particular, those without bank accounts, and is as equally dangerous. So-called installment loans have been called a safe form of consumer credit, but here's the truth about the dark side of installment loans, which was revealed in a report by the independent investigative journalism website ProPublica.
Consumer advocacy organizations have said in the past that installment loans are a safer form of borrowing than payday loans, because they don't have the same large, one-off repayment that can land the borrower even deeper in debt than when they started. It has also been said that installment lenders report lending history to the credit bureaus, so repaying installment loans on time can help a lender improve their credit score.
However, installment loans are not the safe form of borrowing that they might appear to be. Some installment loans have extremely high interest rates and hidden costs and fees that can make this type of $400 loan just as dangerous as a payday loan, or even more so, especially as the amount of money being borrowed is often much higher than it would be for a payday loan.
Just like payday loans, on first sight, the amounts of money involved with an installment loan do not appear to be very large. One of the large installment lenders, World Acceptance Corp, has stated on its website that the average loan it makes to borrowers is $1,180, and the average repayment period was 12 months.
One lady, however, said that she had taken out a loan to cover the $400 cost of repairs to her car. The loan was repayable in seven monthly installments of $80, which made the total amount repaid $560.
The fact that this lady paid interest well above what it would have been on a credit card is only the beginning of what makes this type of loan so dangerous, especially as they are targeted at people who are financially vulnerable.
Installment loans are not the one-time-only solution to a cash emergency that they are marketed as. The truth is that they can be rolled over in exactly the same way that payday loans are.
What's more, the companies that provide these loans are extremely proficient at convincing their customers to take out further loans. In fact, according to the CEO of World Acceptance Corp, renewals of existing loans make up more than 70% of the company's total loan volume.
Senior vice president at the Center for Responsible Lending, Chris Kukla, said that installment loan companies market the refinancing of loans very aggressively to their customers.
ProPublica reported that employees of installment loan companies had been trained to keep customers coming back for more. They would actively look for customers who might be tempted into renewing, because each renewal would mean at least one more month when the customer would be paying nothing but interest.
One customer of World Acceptance Corp had a loan from the loan company with an APR of 90%. This may sound like a lot, but some people pay an even higher APR when they roll over their loans, sometimes as much as 500%.
The way that the repayments are structured means that borrowers repay most of the interest in the early repayments, which means that the people who frequently refinance are constantly paying interest, while hardly making any impact at all on the principal sum of the loan. Chris Kukla says that the fact that some consumers are spending most of their disposable income on servicing installment loans simply proves that these products are not as affordable as the loan industry claims.
One consumer who was interviewed by ProPublica had two installment loans that were over ten years old. The APR on those loans had amounted to more than 800%
There was a crackdown by federal regulators on credit card companies pushing add-on products, for example payment protection plans, but ProPublica reported that similar products are still being aggressively sold to installment loan customers. One former employee of an installment loan company told ProPublica how he and his colleagues pushed hard to convince customers to take out insurance policies that they didn't need and that were optional.
As a result of the Consumer Financial Protection Bureau’s investigations into the payday lending market, payday lenders are channelling more resources into installment loans.
For example, the CEO of Cash America International, Daniel Feehan, told the company's investor conference that Cash America International were attempting to avoid becoming a target for the regulators by focusing more effort on installment loans and less on payday loans. He said that the company was trying to balance consumer demand against the criticism from consumer groups and regulators.
Installment lenders believe that they have slipped under the regulator's radar with installment loans and, for the time being, that would indeed appear to be the case. World Acceptance Corp's CEO Sandy McLean told investors that he does not think that the installment loan industry has become a high priority target for the Consumer Financial Protection Bureau, yet.