The “debt tsunami” sweeping across the United States is being touted as a major cause of our current economic crisis, but many experts are sounding an alarm about the potential dangers of unchecked online lending. Online lending companies are quickly outpacing traditional banks and credit unions in terms of the volume of money they’re making. What is happening? And can it be controlled?
In the past decade, financial engineering by Wall Street investment banks fueled excessive consumer borrowing in the mid-2000s. As home prices and consumer confidence skyrocketed, home equity loans exploded from five-to-ten thousand dollars in value to well over twenty-thousand dollars. As the recession lingers and alternative lenders struggle to survive, online fintech lending companies now seek to capitalize on the problem by targeting subprime borrowers with higher interest rates than even high-end credit cards carry. As the industry becomes more crowded, borrowers are stuck between a rock and a hard place: either they must keep applying to more lenders or they must cut back on other expenses to avoid defaulting on their loans.
Unfortunately, the situation looks like this: fintech lending companies have profited greatly from the boom in consumer credit, and homeowners are now stuck between a rock and a hard place. They either need more cash to pay off existing debt, or they need to take out additional loans to make up for an eroding housing market and employment levels. But in order to avoid default, borrowers are being forced to choose between eating away at their income and paying off their mortgage and car loans. Many are taking out second mortgages and other types of financial assistance, but the result is similar: they are not reducing their debt but increasing it at the same time. This, in turn, has dire implications for American consumers.
“While the overall economy has picked up somewhat, we’ve seen declines in personal lending, particularly in subprime areas, which leaves borrowers in a tough spot,” says John Ulrich, president of the Consumer Financial Protection Bureau, or the CFPB. “Borrowers aren’t taking the right steps to mitigate their risk – they’re putting their income on the line every month,” he continues. The solution?
If you’ve been paying attention to the biotech industry, you’ve probably noticed one common thread: lending practices frequently involve a heavily leveraged secondary market. Secondary markets are places where investors trade contracts (called repo investments) for the right to collect payments from borrowers when they can’t meet their obligations. Fintech investors usually participate in these transactions, buying mortgage notes on homes that sit idly on the property market but are not being occupied. When these mortgages begin to default, banks and other creditors to take a loss. But if a repo investor collects payments from borrowers before the default takes place, the bank loses less money.
There are a number of strategies used by biotech companies to increase their exposure to this secondary market. One is to buy loans from borrowers who are not actually delinquent. Another is to collect monthly, quarterly, or yearly payments from borrowers with good credit histories. Still another strategy is to purchase loans that are already underwriting and servicing thousands of other similar deals. And that’s just the tip of the iceberg; many of these companies use a variety of other strategies to entice new business.
Unfortunately, traditional bank-based lenders are not all bad. For decades, homeowners have taken out loans from traditional banks, secured by home equity and sometimes using traditional credit cards. Recently, however, more homeowners are turning to fintech alternative lenders, even those that don’t engage in the repo activity. In fact, according to the FDIC, in response to increasing complaints about predatory lending practices, several dozen states are investigating and chipping away at their own laws against these lenders.
The bottom line is that anyone considering taking out a loan should take a look at both types of lending options. While it is impossible to say what will happen in the future, the trend so far shows that fintech lenders are going to continue to grow in popularity as both borrowers and lenders understand the differences between the two. The question then is just how much room there is for the business to grow.