With the Federal Reserve buying up bonds and lending at incredibly low interest to banks -- trying to jam as much liquidity through the economic pipes as they’ll take -- it’s now very cheap to borrow money. You'll know that, if you’ve applied for a mortgage or a car loan lately.
But this is only true if you’re middle class or wealthy, with a very good credit score -- perhaps a 700 FICO or above. If someone is poor, and has mediocre credit or little credit history -- perhaps they are an immigrant or work mostly in the cash economy -- then they're likely probably paying an arm and a leg to borrow.
Nancy Yuill sees this problem every day at Innovative Changes, where she is executive director. It’s a nonprofit community lender working with low-income people in Portland, Oregon.
“Their car breaks down, they have a medical emergency, something happens in their life to threaten their financial stability -- and there is no money out there,” she says. “Banks are not lending to these folks. So they have to go to the payday lenders, the consumer finance companies, or ourselves.”
Yuill’s organization offers financial counseling, along with loans of several hundred dollars, paid back over one year in manageable monthly installments. The annual percentage rate (APR) is about 28 percent (18 percent on the loan plus an origination fee). That rate isn’t low -- it’s roughly on par with a Capital One credit card that a borrower with similar credit and income might qualify for. It is low, though, compared to the 100-percent-or-higher rate on a typical payday loan that is flipped a few times before being paid off.
“All of our borrowers have low credit or very poor credit,” says Yuill. “But we see they can make good, responsible loan decisions, and make their on-time payments. And that’s one of the reasons we report that to the credit bureaus, to help them build their score. We believe that many people with poor credit or no credit deserve an opportunity to build a good credit history by managing a responsible loan.”
Which can, eventually, help them qualify for a home-, education-, or small-business loan. Or, just get back on their feet.
Sonja Snyder is 57, single, and makes $27,000 per year answering phones at a building supply company in Portland. She works full time and has been with the same employer for years.
Snyder got behind on student loans, and tax bills, then got hit with some big uninsured medical bills. She took out a high-cost installment loan (from a mail-order out-of-state lender) for $500. After several months paying off that loan, she found herself owing more than she’d originally borrowed. So she borrowed from Innovative Changes to try to turn the debt cycle around.
“I’m trying really hard to rebuild my credit,” Snyder says. “Yes, it [the loan from Innovative Changes] has a high rate of interest. But for someone as challenged as I am, I couldn’t get a conventional loan. I’m a little less stressed now. I’m still pretty nip-and-tuck, but that’s the way I live.”
Snyder says she’ll avoid unconventional and payday lenders from now on. She says she keeps two credit cards now -- with credit limits of less than $200 -- which she uses to buy work clothes. “Unfortunately, I work in the real world,” she says. “I can’t shop at Goodwill all the time.”
The problem for lenders -- for-profit banks, or nonprofits, like community lenders and credit unions -- is that borrowers like Snyder are risky. At Innovative Changes, about 12 percent of outstanding loan balances aren’t repaid.
Yuill says no bank would tolerate that level of loan losses. “A bank generally is looking at a loan-loss below one percent,” she says. “That’s what they’re comfortable with.
And after being burned in the financial crisis, in part by loose lending to subprime borrowers, mainstream banks are going to stay away from risky loans now, says Jennifer Tescher at the Center for Financial Services Innovation.
“The Fed has obviously opened up the spigot as wide as possible,” says Tescher. “Money is flowing and it’s incredibly inexpensive. But banks have the exact same requirements and expectations around risk that they did before -- in fact, they’re even tighter. And I think we want it that way.”
Tescher says the big banks, and even more commonly, small community banks and credit unions, are dipping their toes into the subprime market and lending a bit more to low-income consumers. That’s as the economy improves and credit standards loosen—a bit. And she says the smarter financial services companies are using data other than -- or in addition to -- traditional credit scores to search out the more reliable loan prospects in this demographic.
“They’re using nontraditional sources of data that go well beyond the credit score, that take them further down the credit ladder,” she says. “People are making all kinds of regular payments -- like rental payments, for example, or paying their electricity bill every month -- and those things aren’t generally counted in your credit file.”
Tescher says the Dodd-Frank financial reform promised some expanded lending to the poor and those with challenged credit, but so far it hasn’t panned out. A loan-loss reserve pilot fund was supposed to be set up that private banks could participate in. But Congress hasn’t appropriated the money.
And right now, that leaves responsible lending to the poor largely in the hands of credit unions and nonprofit community groups with limited funds at their disposal. And it means all the Fed's fiscal stimulus money is flowing to banks, businesses, investors, and middle-to-high-income borrowers.
“The Feds have put out low rates for the banks,” says Yuill. “But that has not gotten passed on to more willingness to take on risk. Banks are holding on to that low-cost money, and just lending to the top prime borrowers that are already their customers.”