Online lenders are framing themselves in virtuous terms, claiming that digital innovation has enabled underserved U.S. consumers to refinance expensive debt at lower interest rates, while improving their credit scores.
But provocative new research from the Federal Reserve Bank of Cleveland casts doubt on this optimistic outlook. Indeed, the study reveals that borrowers who use online loan products take on more debt than consumers in the same situation who do not.
“Consumers in the at-risk category – those with lower incomes, less education and higher existing debt – may be the most vulnerable,” the research says.
The study, released Thursday, is likely to spark intense debate. One of its findings is that consumers who take out loans online, sometimes referred to as peer-to-peer loans or market loans, are likely to have access to traditional banking services.
This conclusion is at odds with another recent study by another team of Fed economists. These researchers, based at the Philadelphia Fed and the Chicago Fed, found evidence consistent with the argument that online lenders played a role in filling the credit gap left by banks.
“We’re scratching our heads,” Nathaniel Hoopes, executive director of the Marketplace Lending Association, an industry trading group, said in an email, “because the Federal Reserve in Philadelphia and Chicago recently conducted a more detailed study. and came to the conclusion opposite to it. Cleveland Fed research.
Online consumer loans have seen tremendous growth throughout this decade. In 2010, digital lenders generated $ 249 million in unsecured personal loans, according to a recent study by credit bureau TransUnion. Last year, the annual volume of loans had increased by more than ninety.
The infant industry has generally been encouraged by policy makers. Towards the end of the Obama administration, the Treasury Department declared that online loans have the potential to expand access to affordable credit for underserved consumers.
The Cleveland Fed study comes to a more unfortunate conclusion. He finds that the online industry lending “does not go to markets underserved by the traditional banking system” and “looks like predatory lending in terms of the segment of the consumer market they serve and their impact on. consumer finances ”.
To conduct the study, the researchers relied on data from TransUnion. They identified around 90,000 people who took out a loan online between 2007 and 2012. They then used a statistical technique to compare these borrowers to other consumers with similar financial profiles, but who did not take out loans online. .
The study found that consumers who took out loans online increased their other debt by about 35% more over the next two years than their counterparts who didn’t take loans.
It also found that consumers who borrow online had lower credit scores, more overdue accounts and more total debt two years later than similar consumers who abstained.
The results suggest that online loans – which are often three- to five-year installment loans of up to $ 30,000 to $ 40,000 – allow some American consumers to overspend. Even though borrowers use the loans to pay off existing credit card debt, nothing prevents them from accumulating significant new tabs on those same cards.
Yuliya Demyanyk, a Cleveland Fed economist who co-wrote the research, said in an interview that people who apply for loans online also get credit from the traditional banking system.
“They are not underfunded, they are kind of overburdened,” she said.
Demyanyk also expressed concern about rising late payment rates in the online lending industry. His research found that delinquency rates for online loans created in 2013 were higher than those created in 2012, which were higher than those created in 2011. A similar pattern of rising delinquency rates appeared on the subprime mortgage market between 2001 and 2007.
“I actually had a déjà vu moment,” Demyanyk said.
One potential criticism of the Cleveland Fed study is that it fails to distinguish between different online lenders who target different consumers and charge widely divergent interest rates.
For example, Social Finance, or SoFi, refinances student loans for consumers with strong credit, while LendingClub offers personal loans to borrowers who often have slightly lower credit scores, and some other companies charge annual percentage rates. well over 36% to customers who might otherwise turn to a payday lender.
Cleveland Fed research looked at loans classified by TransUnion as online loans. A list of specific companies included in this category was not available.