Over the last 10 years, investors funneled many billions of dollars into the personal loan market. These investments came in the form of venture capital, various bond structures and even direct investments in loans. Fueled by this influx of capital (and some innovative technologists), the once stagnant personal loans industry exploded with double-digit growth rates.
But the latest data shows originations leveling off. In 2017, for instance, originations of personal loans to subprime borrowers — borrowers with a credit score under 600 — declined for the first time since 2012 (source).
Has the personal loan boom reached its peak? SuperMoney’s 2018 personal loans industry study will answer that question while also providing a detailed look at the consumer lending sector as a whole. Let’s get started.
What is a personal loan?
Personal loans, also known as consumer loans or installment loans, are closed-end uncollateralized sources of credit. This means that, unlike mortgages and most auto loans, they don’t require a security or collateral. And unlike credit cards, they have fixed payments for a specific period of time.
A brief history of personal loans
Although borrowing is as old as mankind, large-scale lending operations have focused primarily on secured loans for most of history. Secured personal loans were usually based on property, such as mortgages, vehicles, family heirlooms (pawn loans), or next season’s harvest.
The reason is obvious. Few lenders want to risk being left with a handful of worthless loan contracts. Asking for collateral made lending a viable business. Unsecured loans were mainly left to fringe and underworld lenders who had other methods to secure their investment.
After World War II, new forms of credit –such as payday loans, credit cards, overdraft protection, bank lines of credit, and unsecured personal loans– became more popular.
Personal loans, credit scores, and statistics
Dramatic changes in technology and financial theory have accelerated the growth of unsecured personal loans. Lenders now have access to mountains of publicly available financial data and the credit scoring tools and software required to analyze them. The advent of centralized credit bureaus and credit scoring models are a driving force for unsecured lending.
Now, lenders can base decisions on applied statistics instead of relying entirely on human judgment. This makes underwriting unsecured personal loans faster, cheaper, and financially viable. As of 2017, only 0.74% of personal loans are delinquent (90 to 180 days past due) (source).
So how big is the personal loans industry?
As of July 2017, the Federal Reserve Bank estimated the value of consumer loans, at all commercial banks, to be $1.380 trillion in the United States, alone (source). Worldwide, consumer lending balances at the beginning of 2016 were $42.3 trillion.
Consumer unsecured loans, also known as personal loans, only represent a small percentage of consumer debt. However, its size varies depending on who you ask and how you define personal loans.
The size of the personal loans sector more than doubled in the last five years
The personal loans sector has seen double-digit growth rates in the last four years
In any other market, the 2017 growth rate of 10.8% would be something to celebrate. However, it almost looks ominous after the spectacular growth rates of 2014 to 2016.
After a period of dramatic growth, loan originations have started to drop
Despite the growth in outstanding balances, the number of new originations dropped in 2017.
The median value of installment loans has more than doubled in the last 25 years.
The balance of personal loans for families was $17,100 in 2016. That’s more than double the median amount in 1992, even after taking inflation into account ($7,800 in 2016 dollars).
Nevertheless, unsecured loans have a lot of room for growth. According to the Federal Reserve’s 2016 Report on Economic Wellbeing of U.S. Households, only 10% of respondents applied for a personal unsecured loan in the previous year. The big players on consumer credit are credit cards (65%) and auto loans (26%).
Personal loans may be the easiest form of unsecured credit to qualify for.
In 2016, one in three credit card applicants were denied at least once. Only one in four personal loan applicants were denied. Student loans have a lower denial rate (14%) but that’s because 92% of student debt is made up of federal student loans (source), which are subsidized by the government.
FinTech lenders are fueling the growth of new lenders in the personal loans sector
Since 2010, the personal loans sector has seen a sharp increase in the number of lenders and significant shifts in the market share of unsecured installment loan balances.
According to a 2016 TransUnion report, in 2015 there were 51 more lenders that were generating at least 10,000 annual installment loan accounts than there were in 2010. The type of lenders dominating this sector has also shifted dramatically.
In 2010, Fintech (financial technology) lenders only represented 3% of the sector. Banks, credit unions, and traditional finance companies each had roughly a third of the market. In 2015, Fintech lenders became the biggest lender type in the sector with a 30% share.
Although all lender types lost ground to Fintech lenders, traditional finance companies were the biggest losers with a 13% drop in market share (source).
What is a fintech lender?
A fintech lender is an online lender that bases its underwriting, risk assessment, funding, and marketing on financial technology. Most lenders, including traditional banks and credit unions, now fit this description. But the term is generally used for startups and relatively new firms that operate exclusively online and use alternative data sources and new credit models that traditional banking channels don’t consider.
Personal loans are no longer a ‘subprime product’
The personal loan sector has the reputation of being a product for higher risk consumers. Although subprime borrowers are still well represented, most of the growth is in the prime and near-prime risk tiers. As the market grows, the lion’s share of personal loans is shifting to moderate risk borrowers.
Near-prime and prime borrowers represented 60% of originations for credit unions and traditional finance companies and 59% of Fintechs’ originations.
One of the key advantages of ‘fintech lenders’ is that they have been more willing to expose themselves to regulatory risk around using alternative data sources for underwriting or leveraging emerging technologies like machine learning in their underwriting algorithms. While these emerging technologies may be able to more accurately determine the default risk of potential borrowers, legal grey areas exist around disparate impact on protected classes or providing proper adverse action documentation, for example. (source).
What are the key business models and capital sources for personal loan lending?
There are three key models personal loan lenders use to source capital. Some lenders combine multiple capital sources in hybrid funding models.
- Fractional Reserve Banking – In the traditional banking model, loans are funded from the deposits of bank customers. This is the method banks (such as Discover or Bank of America) and credit unions use.
- Direct or Balance Sheet Lending – Loans can also be funded by the balance sheet of the loan origination company, also known as balance sheet lenders. These lenders may issue bonds/credit facilities to fund their balance sheet and then lend out money at enough of a premium to make a profit. Their credit facilities are typically secured by the loan portfolio. Balance sheet lenders may also choose to sell off groups of loans in securitizations to provide liquidity. Fractional reserve banking gives banks a significant cost of capital advantage. As a result, balance sheet lenders tend to be more popular in the non-prime space which banks tend to avoid and where higher interest rates can better support the arbitrage occurring. NetCredit is an example of a direct balance sheet lender.
- Marketplace Lenders – Finally, some companies use a marketplace model where prospective borrowers can access funds from investors who invest directly into loans. In this model, the marketplace investors take on the default risk and earn interest directly on the loans they fund. The marketplaces themselves generally earn an origination fee for originating the loan and a servicing fee while the loan is still active. Marketplace lending companies, such as LendingClub and Prosper, primarily use this business model. However, many companies also take some of the risk by funding part of the loans with their own funds (balance sheet lending) in a hybrid model, such as Avant.
Marketplace lending platforms and unsecured loans
Marketplace lending platforms are changing the way individual consumers and small businesses shop for loans, by combining big data with innovative financial tools. These new lenders offer new anti-fraud mechanisms and sophisticated credit models that are attractive to borrowers and investors alike.
According to a report by PwC, 56% of banking CEOs are concerned about the threat of new entrants in the lending industry, and 81% are worried about the speed of technological change (source).
Who is the target audience of unsecured consumer lending?
Unsecured personal loans are a popular source of credit. But what type of consumers apply for unsecured consumer loans?
This is what we know about borrowers of installment loans:
In the last 27 years, the percentage of families with installment loans has remained stable across all family structures (source).
There is a strong correlation between having children and installment loans. Age is also an important factor. About 60% of couples with children have installment loans, while only 7% of single people over 55 without children have them (source).
The median value of installment loans has doubled for most demographics. Couples without children are the exception. (source).
Upper-middle-class families are the most likely to have an installment loan. Around 60% of families with incomes between the 40 and 90 percentile have an installment loan. But families with the 80% to 90% highest incomes were the most likely to have an installment loan.
Why do people get personal loans?
One of the attractions of personal loans is you can use them for practically anything. Consumers use them to pay for luxuries, such as vacations, expensive weddings, or large purchases, or to cover unexpected household expenses, such as home or car repairs. More than 50% of installment loan borrowers had less than $5,000 in their emergency fund (source).
SuperMoney currently generates tens of thousands of personal loan applications per month. According to SuperMoney’s loan application data, the main reason borrowers get a consumer loan is debt consolidation (35%), household expenses (19%) and medical expenses (9.9%).
Repeat customers are a big opportunity for lenders
A 2017 report by Experian revealed that 67% of personal loan borrowers had a balance on their credit cards and 31.5% of the borrowers who paid off a personal loan applied for a new loan within a few months.
According to the same Experian report, 68% of borrowers that get a new loan shortly after closing another installment loan do so with the same company (source).
What is the state of personal loan delinquency rates?
After rising to a high of nearly 1.4% in 2009, 90 to 180 days-past-due delinquency rates have dropped to pre-recession rates of 0.74%. Delinquency rates for borrowers 60 to 89 days-past-due are down to 0.49% as a national average (source). However, not all states are made equal when it comes to delinquency rates.
Alaska is the state with the lowest delinquency rate
Alaska is the state with the lowest delinquency rate for personal loans with a 0.16% 60-89 days-past-due (DPD) rate. The state with the highest delinquency rate was Georgia with a 0.77% DPD (source).
These delinquency rates are at historical lows. However, the debt burden on American consumers is close to all-time high levels. Overall personal debt — including mortgages, auto loans, and student loans– hit $12.9 trillion in 2017.
What is the future of consumer lending?
Personal loans have sustained regular growth in recent years and reached their pre-recession levels. We have seen a 20% increase in the last five years. The average debt balance per borrower in unsecured personal loans has also grown consistently. In 2014, it was $6,315. By 2017, it grew to $7,781, a 0.5% increase from 2016 (source).
This growth is starting to stagnate. Personal loan balances grew in 2017, but only by 10.8% to $107 billion, according to TransUnion. Originations, on the other hand, dropped by 6.9% (2.8 million). when compared to 2016.
If you’re paying attention to the numbers, you may be asking yourself how is it possible for balances to grow while originations drop. The answer is that while the number of new originations is slowing down there are still new loans. Borrowers are also taking on increasingly larger loans and taking longer to pay them off.
What is causing this decline in growth?
It’s impossible to point to one cause but these factors are certainly playing a role:
- This cooling off comes on the tails of aggressive venture capital fundraising that fueled a battle for market share. In many cases, funding for marketplace lenders was flush but ultimately fickle.
- The online borrowers of several important players, such as SoFi, Prosper, and Avant, defaulted at a higher than expected rate. In some cases, the losses were high enough to hit key triggers on the bonds backed by the loans. These triggers can divert the cash flow from loan payments to paying investors early instead of continuing to pay interest. The practice is often called “early amortization,” and can mean investors lose interest or even part of their principal investment.
- Many lenders went out fo business, including CircleBack Lending Inc. a pioneer in the consumer lending business.
- LendingClub, the largest marketplace lender in the business, fired its CEO over irregularities in lending practices.
All this drama made investors nervous, which caused equity and loan capital sources to dry up.
What do these developments mean for the consumer lending industry?
First, it is important to note that 2016 was a good year for the consumer lending market. There was an increase in borrowers, loan balances were higher than ever, and delinquency levels stayed low.
The economic fundamentals of consumer lending are encouraging. Consumers have greater access to credit. As of 2017, there are over 200 digital lenders in the U.S. alone, and Morgan Stanley predicts global volume reach $290 billion by 2020.
What is driving the increase in lenders?
According to Dr. Nonna Sorokina, Professor of Finance at The College of New Jersey, “ The widespread availability of reliable and secure internet services, increasing coverage of the population and relatively easy and inexpensive access to extended geographic area lowered barriers to entry into the industry and prompted a rapid growth in new entrants.”
Online lenders, such as Rise and NetCredit, have penetrated previously underserved areas where there was little or no competition from traditional banking services. Lower income borrowers and people who live in areas without access to bank branches now have more options.
These new entrants may not always have the deep pockets of traditional banks but they don’t have to deal with the same regulations as traditional banking institutions. As Julapa Jagtiani and Catharine Lemieux argue in a report on Fintech Lending for the Federal Reserve Bank, “Fintech has been playing an increasing role in shaping financial and banking landscapes. Banks have been concerned about the uneven playing field because fintech lenders are not subject to the same rigorous oversight.”
Is this growth sustainable?
“In the near-term, I would not be overly optimistic regarding the growth in consumer loans,” says Dr. Sorokina.
Predicting financial trends is risky but two trends indicate that this growth will level off: interest rates and competition.
Interest rates have been at historic lows for nearly a decade but The Federal Reserve Bank is gradually increasing them. Higher interest rates will probably reduce lending volumes.
The other factor is competition. As Dr. Sorokina explains, “Competition is generally viewed as a positive force, but it is much more complex in banking. Competition in banking is known to increase the risk for the economy and to backfire eventually. Think how mortgage loans were cheap and available to nearly anyone recently, and how the resulting crises hit hard on those same consumers. Since then, regulators pay more attention to lending practices that result from increased competition.”
The Bottom Line
Here’s a quick summary of what we know about the personal loans market.
- The consumer lending market is a favorite source of credit for millions of consumers and it’s growing.
- Household expenses, debt consolidation, and medical expenses are the main reasons consumers get a personal loan.
- However, the growth rate of new loan originations is stagnating.
- Nevertheless, the consumer lending market still shows solid economic fundamentals.
- The access to credit for consumers has increased and so have personal loans’ balances.
- Delinquency rates are low.
- Interest rates are rising, which could reduce consumers appetite for credit.
Consumers like personal loans because they offer lower interest rates and a faster distribution of funds than most other sources of credit. However, rates and speed of funding vary widely from one lender to another. Borrowers can save money by comparing rates and terms before accepting a loan offer.