Credit cards and installment loans are consumer lending products, but they vary in objectives and terms. Credit cards provide consumers with a transaction or lending function that enables cardholders to draw funds on a revolving basis within a prescribed credit line. Payments vary based on the outstanding billed balance, typically in the range of 1/36 of the amount due plus assessed interest. The good news about the minimum due is that it is relatively low.
The bad news is that if you only pay the minimum due, a $3000 balance will take 11 years to repay, and the financing cost would be about $1,745. On the other hand, if you were to repay slightly more than the estimated amount of $90 minimum due, let’s say $103, repayment would be in three years. Spoiler alert: never pay the minimum due.
Now consider the installment loan. With this lending vehicle, you will typically receive the funds at closing, and throughout an agreed-upon schedule, you will repay the loan. You will not have the capability to get additional funds, as you would with a credit card, unless you refinance or renew the loan, or get another loan elsewhere. Installment lending was somewhat of a sleeper business for banks, but with the emergence of BNPL, bankers need to think about how consumers’ preferences might change over the rest of the decade. Sure, you can rent a car without an installment loan, but if you want to buy a boat or consolidate all those credit card bills you may have accumulated, an installment loan could be a good option.
Recently published numbers by TransUnion, a top credit bureau, indicate that installment loans are in a rapid growth mode. Although they did not have the 124.2% year-over-year origination increase that bank cards enjoyed as the industry rebuilt from the COVID trough, personal loan originations grew by 69.9% YOY. And, balances increased by 5.6%, while bank card balance growth increased by a mere 0.5%.
TransUnion numbers indicate that banks and credit unions provide 81% of credit card products, with 19% by finance companies, fintechs, and others. In contrast, banks and credit unions only have a 58% share of personal loan volume. Considering how financial institutions got blindsided by BNPL uptake, perhaps it is time to consider the potential of installment loans in the financial institution lending mix.
Watch for more on installment lending this month as we unveil our market view of installment lending and how it can impact your loan books.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group