Products-in-a-Box: Small Dollar Consumer Loans

SDLs can play an important role in addressing credit needs and helping to close gaps in a household’s cash-flow. As jobs become less predictable and income volatility is on the rise, households (particularly low-income households) are having a hard time making ends meet and planning ahead.13 One study found that even median income households experienced income fluctuations of $500 from month to month.14 Another study revealed that just under half of American families spend more than or all that they earn every month, and lack a substantial savings cushion to make up for any deficits.15

When households are unable to makes ends meet, many rely on credit. An estimated 15 million consumers annually, at all income levels, access small dollar credit that doesn’t come from a mainstream financial institution. Most commonly SDLs are used to pay utility bills, general living expenses, and rent.16 Often consumers resort to SDLs when their living expenses are consistently more than their income, a bill or payment comes due before their paycheck arrives, and/or due to an unexpected event such as an emergency or an abrupt change in income.17

There is a clear need for SDLs but at the same time a dearth in affordable, safe products. Many mainstream financial institutions have shied away from providing SDLs due to the tensions between affordability and profitability. In addition, many consumers are un-or under-banked and seek credit options outside of the mainstream financial sector. Indeed, a fringe industry of lenders who provide payday loans, high cost installment loans, and auto title loans has emerged and capitalizes off of consumer urgency. Payday loans alone cost 12 million Americans $9 billion in fees a year.18

This is where nonprofit lenders come in. Currently, Credit Builders Alliance enables hundreds of nonprofit lenders across the United States to report consumer and small business loans totaling over $1.5 billion dollars every month. Across the country there are over a thousand Community Development Financial Institutions (CDFI),19 lenders with a mission to serve communities that are underserved by mainstream financial institutions, which have lent an average of $6.8 billion a year since 2011.20 While this industry has come a long way, there is room for growth (think of those 12 million payday loan customers who could benefit from less costly products!) Alternative nonprofit lenders can provide safe, affordable SDLs that fill gaps in a household’s or entrepreneur’s cash flow, and help individuals, families, and small businesses get ahead. The key is creating the right product and effective marketing to reach those who need it.

What is a small dollar loan

11 Center for Financial Service Innovation. “Developing High-Quality, Small-Dollar Credit Products.” Retrieved from http://cfsinnovation.org/research/small-dollar-credit
12 Federal Deposit Insurance Corporation. (2010) “A Template for Success: The FDIC’s Small-Dollar Loan Pilot Program.” FDIC Quarterly, Volume 4, No. 2.
13 Baker, Todd H. (2017, May). FinTech Alternatives to Short-Term Small Dollar Credit: Helping Low-Income Working Families Escape the High-Cost Lending Trap. M-RCBG Associate Working Paper Series, No. 75, Harvard Kennedy School. Retrieved from https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/files/75_final.pdf
14 JP Morgan Institute: Farrell, D. and Greig, F. (2015, May). Weathering Volatility: Big Data on the Financial Ups and Downs of U.S. Individuals. JPMorgan Chase Institute.
15 The Pew Charitable Trust. (2015 January). The Precarious State of Family Balance Sheets. Retrieved from http://www.pewtrusts.org/~/media/assets/2015/01/fsm_
balance_sheet_report.pdf
16 Levy, Rob. and Sledge, Joshua. (2012). A Complex Portrait: An Examination of Small-Dollar Credit Consumers. Center for Financial Services Innovation.
17 Ibid
18 The Pew Charitable Trust. (2016, January 14). Payday Loan Facts and the CFPB’s Impact. Retrieved from http://www.pewtrusts.org/en/research-and-analysis/fact-sheets/2016/01/payday-loan-facts-and-the-cfpbs-impact
19 The CDFI Fund. (2017, September). “CDFI Certification.” Retrieved from https://www.cdfifund.gov/programs-training/certification/cdfi/Pages/default.aspx
20 Theodos, B., & Hangen, E., (2017, September). Expanding Community Development Financial Institutions. Urban Institute.

A small dollar loan is not just a means of meeting a consumer’s immediate needs. SDLs can also help a borrower establish and/or improve their credit profile. In just six months, for example, on-time payments reported to the credit bureaus on an installment loan as small as $100 can help an individual with a low credit score increase their score by an average of 35 points—and move an individual with no credit score to a prime credit score.21 A good credit history is crucial in today’s economy. Far more than just a number, a good credit score is a prerequisite for every day Good Credit is the Passport financial services like a low-cost credit card, a bank account, or a car loan.

A good credit to the New Economy history can make the difference in accessing the affordable lending products necessary to go to college, buy a home, or start and grow a small business. Renting an apartment, paying for car insurance, signing up for utilities and even landing a job can also be affected by a person’s credit history—or the absence of one.

CBA defines credit building as the act of making on-time monthly payments on a financial product such as an installment loan or a revolving credit card that is reported by the creditor to at least one of the major credit bureaus. Credit building is a powerful financial capability strategy to help individuals and small businesses take control of their financial lives. By engaging in credit building activities they can access opportunities, reduce expenses and also build assets. Offering small dollar loans to your community helps people address a real need for credit, while also offering them an opportunity to pursue other financial stability and asset-building goals through credit building!

21 Chenven, Sarah. (2014) The Power of Credit Building: Credit Building Strategies for Funders. Asset Funders Network.

credit strength framework

CBA’s Credit Strength Framework© (see diagram above) guides organizations in taking a comprehensive approach to helping consumers build strong credit through knowledge, access, and action. As a practitioner, you can help them in achieving these three elements of credit strength:

Knowledge involves credit education that helps clients understand their own credit profile and how the decisions that they make will influence it.

  • For instance, lending programs often use the application process as a time to help potential borrowers learn about their credit report.

Access is about connecting clients to the products that they need in order to build strong credit.

  • Providing small dollar loans and referrals to other financial products are key ways of increasing access to building strong credit.

Actions includes the use of financial products and the ongoing positive behaviors needed to build and sustain strong credit.

  • For example, nonprofit lenders can structure loan repayment in a way that facilitates ease of borrower repayment and can help promote positive financial behaviors that
    build credit.

CBA believes that all three of these elements are critical to a successful credit building program. This is also what makes credit building such a clear financial capability strategy. See Appendix A for more details on how to incorporate the Credit Strength Framework into your lending program.

Financial Capability Services

financial capability services
Graphic from: United States Department of Health and Human Services. Building Financial Capability: A Planning Guide for Integrated Services. Washington, DC: Department of Health & Human Services, 2015

Access to a financial product is a key step towards building both credit strength and financial capability. A distinction in terminology notes that credit building is more narrowly focused on the establishment and/or successful management of credit products; whereas, financial capability—the capacity, based on knowledge, skills, and access, to manage financial resources effectively22 —is more multifaceted though still intertwined with credit building. As seen in Figure 1, building financial capability can involve a host of different activities, such as financial education, financial coaching, incentivized saving, free tax preparation, asset ownership programs, and credit building. For those who lend or advise on access to credit products, this can mean:

  • Leveraging interactions with borrowers as “teachable moments.” For example, when signing a loan agreement with a borrower during the loan closing process, you could use this time as an opportunity to walk them through the document in detail, highlighting particular areas around repayment terms, etc. Throughout this guide, we will suggest points in the loan process that could be used as “teachable moments.”
  • Finding ways to offer more credit building activities, or other financial capability programming in-house. For example, consider pulling a soft-inquiry credit report for your borrowers as part of the application review process. You could use this time as an opportunity to show them how to pull and review their own credit report in the future. For more information on integrating activities to help clients build credit strength into your program, see Appendix A: Credit as an Asset Framework© and Appendix A: Credit Strength Roadmap©.
  • Searching for referral partners that provide complementary financial capability programming. This could be as simple as displaying flyers and information about your program or making warm referrals at specific points in the loan process. For example, once a borrower who is working to establish a credit profile makes a certain amount of on-time loan payments, you could refer them to (and/or help them apply for) a secured credit card at a local bank or credit union. If you are unsure of what services exist in your community, you can start by taking inventory of what is out there, using United States Department of Health and Human Services’ financial capability inventory tool (see “Planning Guide for Building Financial Capability”).

22 United States Department of the Treasury. Amended Charter: President’s Advisory Council on Financial Capability. Washington, DC: Department of the Treasury, 2010.

RESOURCES

The United States Department of Health and Human Services’ “Planning Guide for Building Financial Capability” guides organization through integrating financial capability programming and services into your current offerings (through internal or external initiatives).