Affordable Credit Poised to Save Consumers Billions

Overview

The mainstream financial system is becoming more inclusive as the recent rapid growth of small-dollar loans from banks and credit unions has made it possible for millions of consumers with low or no credit scores to borrow safely. Unlike high-cost credit products from payday, auto title, pawn, and rent-to-own providers that cost Americans more than $20 billion annually, small loans from banks and credit unions include strong consumer safeguards, much lower prices, adequate time to repay, and payments that consume only a small share of borrowers’ income.¹

As of April 2023, six of the eight largest U.S. banks by branch count, which collectively operate 23% of all bank branches, had rolled out small installment loans or lines of credit that cost at least 15 times less than average payday loans.² Numerous smaller banks and credit unions also launched similar products in 2022, often with the assistance of technology vendors, and adoption at smaller institutions is increasing: Credit unions participating in the National Credit Union Administration’s (NCUA) Payday Alternative Loan program set a record for new loan volume, reaching an all-time high with $227 million originated in 2022, eclipsing the previous mark of $174 million set in 2019.³

This trend has been supported by federal regulatory guidance, issued in May 2020, that enabled banks and credit unions to offer automated small loans to their customers, including millions of Americans whose credit scores would otherwise not qualify them for loans from banks.⁴ Each of these loans offers hundreds of dollars in savings compared with payday loans, and even more compared with vehicle title loans and rent-to-own agreements, with annual savings for former high-cost loan borrowers likely to reach billions of dollars.⁵

Further, these loans have the potential to provide a safe, affordable alternative for most of the nation’s low- and no-credit history borrowers. The first requirement to access these small credit products is having an account and transaction history at the bank or credit union issuing the loan, and more Americans than ever before—95.5% of households—meet those criteria. That includes everyone who uses payday loans, which require borrowers to have a checking account. This means tens of millions of people whose credit scores have previously excluded them from bank or credit union loans could soon have access to an affordable small-dollar credit product so long as their financial institution decides to offer one.⁶

In light of the dramatic expansion of bank and credit union small lending since 2018, Pew examined the latest consumer and market research and updated its 2018 standards as follows:⁷

• Access. Credit should be available to existing bank and credit union customers who need the most help, are able to repay, and do not qualify for other loans.
• Affordability. Loans and lines of credit should offer enough time to repay, usually at least three months, so that each installment consumes only a small share of a borrower’s income.
• Fair pricing. The total cost of the loan should be only a small fraction of the loan’s principal but be sufficient to ensure the bank can provide widespread access to small credit. Banks and credit unions making these loans readily available have been able to strike that balance successfully with fee-inclusive annual percentage rates in the mid-double digits or lower.
• Speed. Application processes should be fast and easy, leveraging online and mobile banking technologies, and funds should be provided the same day.

This brief discusses the state of bank-issued small loans, explores the regulatory history that has driven their growth, and provides more detail on these updated standards to help more financial institutions begin offering safe, affordable small loans that promote borrower success.

Safe small loans from banks and credit unions benefit consumers

Each year, millions of U.S. consumers in financial distress who have accounts at a bank or credit union turn to risky high-cost nonbank lenders when they need to quickly borrow small amounts of money.⁸ Others have relied on costly overdrafts as a form of small-dollar credit.⁹ And a primary reason that consumers made these choices was because they could not get small loans from their banks or credit unions.¹⁰

Increasingly however, these consumers have a better choice. Most of the largest banks now offer small installment loans and lines of credit to their customers who would not typically qualify based on their credit scores at a cost that is at least 15 times less than payday loans.¹¹ Although loan prices vary across banks, all of them are dramatically lower than for payday loans and other credit from nonbank lenders: On average, to borrow $500 for four months, a borrower can pay $35 or less for a bank-issued small loan compared with $500 or more to use payday loans.¹² Among the six largest banks by branch count, small loans are available for up to $500, $750, or $1,000, with minimum loan sizes ranging from $10 to $250. Some credit unions and community banks offer larger maximums, such as $1,500 or $2,000. Annual percentage rates, including all fees, for loans from major banks are in the 30s or lower, with comparable or somewhat higher rates from some community banks and credit unions.

Additionally—and most importantly for many borrowers—compared with nonbank loans, banks’ small loans better meet the particular needs of low- or no-credit-score customers. Bank and credit union small-dollar loans are easy to access, provide funds quickly during times of financial distress, and give customers sufficient time to repay and recover. They require no travel to a branch and no waiting for an online lender to review an application and transmit the funds. Instead, customers complete short applications via the bank’s website or mobile app, and the bank deposits the funds, usually within minutes, into the customer’s existing checking account. And although nearly all large banks have improved their overdraft policies to make them less costly for customers, the new small-dollar loans from banks still provide a much safer and less expensive way for consumers to meet their credit needs.¹³

Further, customers at some banks have the peace of mind that approval is all but guaranteed, because those banks offer the loans only to customers they have previously determined are probably or definitely qualified and able to repay. These financial institutions primarily or exclusively underwrite their small loans based on account history and cash flow data, rather than relying on applicants’ traditional credit scores, which enables them to confidently lend to consumers who would otherwise not qualify for bank credit.

Ultimately, these new bank loans will especially help the most underserved consumers—particularly people who have no credit history or who are Black, Hispanic, immigrants, or under age 30—because they use high-cost, nonbank financial services and overdraft at disproportionately high rates.¹⁴ The new loans—along with the overdraft reforms—also may make it easier for consumers who often have low account balances to gradually save more money, which is the best safeguard against the frequent financial shortfalls that lead to most small-dollar borrowing.

Joint guidance boosts safe small-dollar lending

Five years ago, not a single large bank offered a small installment loan or line of credit to its customers with damaged or no credit history. But now, six of the top eight provide these products. And they are able to offer them thanks in part to well-designed, stable guidance issued jointly in May 2020 by the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and NCUA.

The guidance laid out clear principles of responsible small-dollar lending, encouraged safe small lending as a means to help consumers weather financial difficulties, welcomed automation and underwriting based on factors such as cash flow and account history, and emphasized the need for affordability and consumer success.¹⁵ This clarity has enabled banks and credit unions to automate their underwriting of low- and no-credit borrowers using basic account data, which helps keep origination costs, and in turn loan prices, low.

Regulators took this step after years of work to study and understand how safe small loans from banks and credit unions could best serve consumers and financial institutions. Major milestones included the FDIC’s small-dollar loan pilot, the NCUA’s Payday Alternative Loan programs (PAL and PAL II), the Consumer Financial Protection Bureau’s (CFPB) since-rescinded 2017 regulation that did not constrain small-dollar installment loans, and the OCC’s 2018 (since-replaced) small-loan guidance.¹⁶ (See Figure 1.)

Figure 1

15 Years of Work by Financial Regulators, Institutions Have Made Safe Affordable Small Credit a Reality

Major events in bank and credit union small-dollar lending

Updated standards for bank and credit union small loans

Pew designed its 2018 guidelines to set safe small loans apart from harmful ones, protect consumers, and enable banks and credit unions to offer safe small credit widely and sustainably.¹⁷ And those standards helped guide the early growth of bank small-dollar lending.

With the many developments since then—the 2020 joint guidance, the new products from large banks, and the growth of small loans from community banks and credit unions—Pew sought to update its standards to reflect the current regulatory and market conditions so that even more banks and credit unions can offer safe small loans for their customers. The new standards address the four key elements of safe small credit: access, affordability, pricing, and speed.

Access: Make credit available to all existing customers who need it and are able to repay

First and foremost, banks and credit unions should offer affordable small loans to their existing customers with credit needs and should prioritize account history and cashflow when underwriting those loans to make credit accessible to all customers who are able to repay but would not qualify under traditional underwriting. This lending approach has proved effective because it is built upon the established relationship between the customer and the depository institution.

The major banks that offer small loans all require at least three months of account history before customers can be eligible for these loans, while some smaller banks and credit unions will lend based on as little as one month of account history. Dozens of banks, credit unions, and the vendors who serve them have already used this method to accurately predict likelihood of repayment and successfully underwrite loans to their customers who have low or no credit scores.

To expand credit access and improve customers’ experience, several banks report they do not conduct additional credit checks, which speeds up the lending process, lowers lending costs, allows banks and credit unions to pre-approve customers based on account history, and enables more customers to qualify. However, other banks or credit unions do obtain a major or alternative credit report.

The impact of these loans on consumers’ credit scores is not yet known and may vary by customer. Not all banks and credit unions report repayment of these loans to credit bureaus, but as lenders and credit bureaus gain more experience with these products, they should evaluate whether reporting small-loan payments to credit bureaus helps raise consumers’ credit scores. And if it does, banks and credit unions should report on these loans.

Affordability: Keep payments small by giving customers enough time to repay

To keep payments affordable, banks and credit unions should give customers enough time to repay in installments, usually at least three months. Pew’s research has found giving consumers at least a few months to repay is an essential consumer protection. An installment structure with adequate time keeps payments much smaller than those for single-payment loans, such as payday loans.

In addition, lenders should review customers’ deposit history and use that information to help determine the payments that customers can afford. U.S. Bank has gone even further to protect its consumers, limiting payments to 5% of customers’ income, which Pew’s research has found is usually affordable even for most nonbank loan borrowers.¹⁸ Banks and credit unions have largely avoided harmful practices such as making loans due in a single payment or giving borrowers one month or less to repay, which Pew’s research has shown is too short to enable customers to repay without quickly needing another loan.¹⁹

Fair pricing: Ensure that loan costs are only a small fraction of the principal but also sufficient to provide widespread access to credit

Because the small-loan market is not price competitive, banks and credit unions—rather than market forces—are responsible for pricing small loans fairly. Fair pricing means that loan charges equal only a small fraction of the loan’s principal but are sufficient to enable banks to lend to all their customers with low or no credit scores who need it and are able to repay.

Because consumers seeking small amounts of credit are usually in financial distress, they prioritize the speed, ease, and certainty of approval of a loan more than its cost and affordability.²⁰ Further, they are not in a position to shop around at other banks for lower prices because small-loan underwriting requires that they have a banking history at the lending institution. As a result, typical market dynamics in which lenders compete for customers by lowering prices do not apply to small-dollar lending in the same way as other loan products.

As more banks and credit unions design small loans, they must strike a balance in identifying appropriate pricing. If they charge too little, they may lose money on each loan, which is a disincentive to widespread access for customers who otherwise lack affordable options. But if they charge too much, the pricing becomes unfair for consumers. To date, banks and credit unions have priced their small loans fairly. Small bank and credit union loans generally have APRs in the mid double digits or lower, including all fees, which the public and payday loan borrowers overwhelmingly view as fair.²¹

So to the extent that providers are deciding whether to keep APRs in the teens or 20s and help fewer customers or charge somewhat higher APRs and help more customers, they should do the latter. Even with APRs that are somewhat higher than those for credit cards, access to these small loans will save vulnerable consumers hundreds of dollars or more compared with nonbank loans, repeated overdrafts, or harmful outcomes such as eviction, auto repossession, or utility disconnection.

Speed: Make application processes fast and easy and provide funds the same day

To serve consumers in financial distress and effectively compete with nonbank providers, banks and credit unions should automate the lending process, including enabling customers to complete a loan application in just a few minutes and obtain funds the same day. Banks and credit unions also should offer easy autopay options for small-loan payments and ensure that the automatic withdrawals from their borrowers’ checking accounts do not result in overdrafts.

Major banks already provide their small loans through their mobile applications and websites, without requiring borrowers to visit a branch. Customers either are pre-approved and need only agree to the terms and select a loan amount and repayment method or apply electronically, improving convenience and keeping lenders’ costs low. And the major banks typically fund their small loans within minutes of approval.

Many banks and credit unions also have streamlined repayment by offering autopay, in which most customers have loan payments automatically deducted from their checking accounts in agreed-upon installments, usually monthly. In addition, these lenders generally avoid triggering overdrafts by only processing the installment payments when sufficient funds are available in the account. These automatic repayment features help consumers successfully repay loans, while also preventing overdrafts and minimizing lenders’ costs and losses. However, customers who prefer to pay manually may also choose that option.

Bank-issued small loans on the market meet Pew’s standards

Pew analyzed the small installment loans and lines of credit offered by large banks, and they all meet Pew’s updated standards. (See Table 1.) The banks offer these loans or lines of credit to existing customers, either pre-approve borrowers or have a quick application process, disburse funds almost immediately, provide terms of three to four months or longer to repay in affordable installments, and charge APRs below 40%. Many other digital and quick small installment loans and lines of credit that community banks and credit unions provide to their own customers, including Payday Alternative Loans and various credit products supported by third-party technology vendors, also meet Pew’s standards.