Online loans may offer pitfalls for the unwary
NEW YORK — Silicon Valley has helped enhance just about every aspect of modern life. Naturally, Mohammad Mansour figured it could help solve his money problems, too.
Mansour borrowed $7,680 from Lending Club, a San Francisco lender offering loans more conveniently and with lower interest rates than a traditional bank. He then got a $10,000 loan from Prosper, another online lender in Northern California.
An accountant from Queens, Mansour earns $64,300 a year. He took out a third online loan and then a fourth. He now owes $31,600. And he is struggling to pay off the debts.
He is one of more than a million Americans who have tasted what many say is the future of finance, in which big banks with outdated branches and skittish risk departments are being replaced by lenders that operate mostly online and match borrowers with investors who buy up large chunks of the loans. Using the latest data and credit algorithms, the lenders can approve loans in minutes.
“Silicon Valley is coming,” the chief executive of JPMorgan Chase, Jamie Dimon, wrote in an annual letter to the bank’s shareholders, warning of the competitive threat these lenders pose to traditional banks.
The loans win plaudits from consumer groups and regulators for their low costs and straightforward terms. The companies say they are providing affordable credit to families and small businesses.
But some of these upstart companies are exhibiting troubling traits, according borrowers, legal aid lawyers, and consumer advocates.
Marketed as a way to improve credit scores, the loans are instead worsening some people’s financial troubles. And when people run into trouble, borrowers and their lawyers said, some of the new lenders are unwilling to modify their loan terms. Some borrowers also took issue with how loan payments were collected.
Borrowers are matched through an online “marketplace” with investors like hedge funds and mutual funds. The lenders operate without some of the regulations that govern mainstream banks, such as rules on how much capital they must set aside for potential losses. But they do have to follow federal laws that require disclosure of loan terms and nondiscrimination, among other things.
Moody’s Investors Service has warned there are similarities to mortgage lending in the period before the 2008 financial crisis, because companies that market the loans quickly sell them off to investors. The companies do not suffer losses directly if the borrowers default, which may embolden them to lower their credit standards, Moody’s said.
The lenders say they have plenty at stake if something goes wrong.
Lending Club, for example, does not earn a fee servicing loans that are written off, giving it less incentive to make risky loans. More important, investors will stop buying the loans if the company takes too many risks.
“I do believe there is promise here, but the industry needs monitoring,” said Gary Kalman, at the Center for Responsible Lending, based in Durham, N.C. “The question is whether these companies will continue to use technology to provide fair loans or use it to gouge people like traditional small-dollar lenders.”
One complaint is the way certain companies collect loan payments. In signing up for loans at Prosper, borrowers must give it access to their bank accounts so it can electronically deduct loan payments. Banks and credit card companies offer electronic withdrawals as an option, but they do not always require them.
Moody’s noted that automatic withdrawals make it more likely that “strapped borrowers” would pay their marketplace loans ahead of other expenses. Prosper says having access to borrowers’ accounts allows it to deposit loan funds quickly and borrowers to make payments easily.
Technological efficiency can also have a dark side.
New Innovative Products, a maker of carrying cases in North Carolina, borrowed $70,000 in December from OnDeck, an online lender. It was allowed to withdraw $604 from the company’s bank account each day. But OnDeck crossed the line, a bankruptcy judge said, when it kept collecting payments after being told multiple times that the company had filed for bankruptcy protection. In July, a judge sanctioned OnDeck and ordered it to return the money.
When borrowers sign up for a Lending Club loan, it defaults to automatic bank withdrawals. The Lending Club website informs borrowers they can opt out, but they have to pay a $7 processing fee for each paper check.
“It is more cost-efficient for us, and we pass those savings along to borrowers,” Renaud Laplanche, chief executive of Lending Club, said of the automatic withdrawals.
Some borrowers like Mansour said they ended up closing their bank accounts because they thought it was the only way to stop the lenders from taking out the money.
“It can lead to people feeling trapped,” said Peter Barker-Huelster, a lawyer at MFY Legal Services in New York, who has advised clients with marketplace loans. “They don’t approach the lender to work out a lower payment because they think there is no way around it.”
Mansour, the Queens accountant, readily admits he made some financial mistakes while trying to raise two children on a single salary in New York.
He said the ease with which he could borrow from marketplace lenders — he took out four loans within 19 months, in addition to his multiple credit cards — enabled him to live far beyond his means. In July, he sought bankruptcy protection.
“I made my mistakes,” he said. “And I am paying for it now.”