Why fintechs—and Snoop Dogg—are in the $160 billion installment lending market

February 19, 2020 11:14 AM

When established card networks such as Visa, American Express and Mastercard start investing in fintech lending platforms such as Divido and ChargeAfter — as well as in the fintech lenders themselves such as Klarna and Vyze — it’s a clear signal that the future of unsecured personal loans may not be delivered by banks.

In justifying its 2019 purchase of Vyze, Mastercard cited an Accenture group study that claimed that the U.S. installment lending market represents a $1.8 trillion opportunity. It may also be one of the reasons U.S. rapper Snoop Dogg decided to invest in more than just his singing career by purchasing a stake in Klarna a year ago.

Today, installment loans cover a variety of uses ranging from purchasing t-shirts and jeans to debt consolidation and alternatives to credit cards. According to TransUnion, the market for unsecured installment loans of all types in the U.S. topped $161 billion in the fourth quarter of 2019.

There has been a clear shift to unsecured installment loans over the last five to six years. In 2013, banks held 40% of personal loan balances ,while credit unions held 31% and fintechs were practically an afterthought at just a 5% market share position, according to TransUnion. At the time, the Federal Reserve Bank of St. Louis noted that personal loans balances were just $49 billion.

By 2018, share position shifted with fintechs owning 38% of balances, compared to banks at 28% and credit unions at 21%. The latest share data from TransUnion (also cited by the Federal Reserve of St. Louis) showed the market almost tripled in size to $138 billion in 2018.

“We’re seeing a massive increase in alternative lending,” said Wayne Best, Visa’s chief economist, at Arizent’s Card Forum last year in New Orleans. Best noted that banks are being disintermediated by fintechs, and it’s happening in all age groups, including the Boomer segment.

“Many people don’t think that Boomers are very tech savvy. They have computers and they know how to use them,” Best said. While Best reported that Boomers would be more likely to use an installment loan as an option for a home renovation or trip than to pay off debt, the effect on the banks is still same — disintermediation.

In the fourth quarter of 2019, unsecured personal installment loan balances stood at $161 billion, which is almost four times the size of the market in 2013, when it was only $49 billion. Based on data from TransUnion, the personal installment loan market is showing no signs of slowing down by its trendline of annual $15 to $20 billion annual loan balance growth.

TransUnion noted that overall total balance growth was the result of larger loan amounts secured by the above-prime population. Additionally, TransUnion noted that overall, the average account balance has remained stable across risk tiers along with performance, which demonstrates that risk is being managed well by lenders.

While many consumers don’t acquire credit cards with the idea of going into debt, sometimes there is a need or a recognition that over the course of the near future a person will need to revolve for purchases such as trip, car repair, or emergency bills. In those cases, credit cards may not be the best choice of loan based on price.

Based on data examined by the Federal Reserve Bank of St. Louis supplied by Mintel, the average acquisition interest rates (APRs) offered to near prime, prime and super prime credit scored consumers by fintech installment lenders were slightly below to significantly below the APRs offered by credit card firms. For super prime consumers, the difference was as large as four percentage points annually.

For consumers who initially don’t expect to revolve credit card debt, but end up doing so over the course of time, fintech installment loans are finding a welcome market due to their lower annual cost. The Federal Reserve estimates that just over 22% of installment loans (from banks and fintechs) are used to pay off high interest rate credit card balances.

There is a growing usage of installment loans simply to complete purchases and not to consolidate or pay off credit card debts. These loans are increasingly being made by companies such as PayPal Credit, Affirm, Klarna.

In a 2019 Arizent survey of 150 leading internet and brick-and-mortar retailers with an e-commerce site, Installment Lending: More profit at point of sale, it was found that of the 91 retailers that offered installment loans to be used to complete purchases, 70% were for a duration of 12 months or less. About one third (35%) were for durations of six months.

In cases where a 0% interest rate was offered for a short period, such as six months, quite often consumers could extend the loan. However, those loans tended to have high “Go To” APRs that approached 25% to 30% for the consumers who extended the loan beyond the original trial period. Further, most of the teaser loans had retroactive interest which was applied from the start of the loan.

The rise in consumer e-commerce shopping is having a distinct influence in how people pay for goods and services acquired by phone or computer. According to the Commerce Department, in the third quarter of 2019 approximately 11.2% of all retail sales, excluding gasoline, were purchased online, up 16.9% from the same quarter one year earlier. Total retail sales for the same period was up only 1.4%.

Given the popularity of online shopping, how consumers complete the purchase is partly dictated by the options offered by the merchants.

Arizent's Installment Lending: More profit at point of sale report found that card acceptance was not universal. While Visa and Mastercard credit cards were accepted by all of the merchants in the study, only 25 accepted debit cards. Follow-up interviews with retailers found that risk concerns played a major role in their decision to accept debit cards on an in-store-only basis.

One of the factors leading to the rise in low value, short-term installment loans is this lack of support for credit card alternatives such as debit cards.