The Importance of Good Credit in Achieving Financial Stability
Our monthly Viewpoints series invites guest authors from outside of Wells Fargo to share an important perspective related to their work. Today, we welcome Dara Duguay, CEO of Credit Builders Alliance.
An unbelievable 44% of adults say they either could not cover a $400 emergency expense, or could only cover it by selling something or borrowing money, according to the Federal Reserve’s 2016 Report on the Economic Well-Being of U.S. Households.
Do holiday gifts qualify as an emergency? Most people would probably say yes if the alternative was arriving empty-handed. Obviously, access to credit helps people manage the unexpected expenses that are a part of life — like a car repair or a sudden job loss — but credit also helps us manage those expected bills, like holiday shopping expenses.
Yet, what if you can’t access credit? According to Experian, 64 million Americans have no credit or a thin file. Sure, there are payday lenders and car title loan companies that may be able to help them, but at what cost? For these Americans, borrowing money at an affordable cost is challenging, if not impossible.
A typical scenario is a $400 car repair that needs to be paid before a single mother can get her children to day care and herself to work. Lacking transportation, this scenario quickly results in lost wages and potential unemployment. However, when she takes out a payday loan to fix the car, she could end up paying two or three times the amount of the original loan in fees alone before it is fully repaid. On average, payday loan borrowers end up indebted for five months, paying $520 in finance charges for loans averaging $375, according to Pew Charitable Trusts (PDF).
So although a payday loan might solve an immediate problem, afterward the borrowers find themselves stuck in an unsustainable cycle of debt. In fact, a 2014 study by the USPS Office of Inspector General (PDF) found that “25% of U.S. households rely on costly nonbank services to manage their everyday finances, causing low-income families to spend the same share of their income on interest and fees as an average family spends on food.”
Instead of providing a panacea, unaffordable loans exacerbate a family’s financial instability and create overwhelming psychological and physical stress.
By contrast, what if responsible and affordable loans were accessible and allowed people to weather their short-term financial setbacks to their long-term advantage? This is where Community Development Financial Institutions, or CDFIs, and other nonprofit lenders come in. CDFIs are private financial institutions that are 100% dedicated to delivering responsible, affordable lending to help low-income, low-wealth, and other disadvantaged people and communities join the economic mainstream. They are often the only lenders who will provide reasonably priced loans to someone who is credit invisible (lacking a credit history) or has poor credit.
Since 2006, Credit Builders Alliance has worked with CDFIs to help low- and moderate-income individuals and families build strong credit and other financial assets. We like to refer to our nonprofit members as the “training wheels” lenders. A loan from a CDFI, if managed well, will save people significantly on interest costs while also building a credit history. To help accomplish this, one of our core services is to act as a bridge to the major credit bureaus, so that CDFIs can report their borrowers’ payments. Once a borrower has a positive credit history and a strong credit score, they are able to graduate to the financial mainstream — qualifying for credit cards, car loans, and mortgages.
The good news is that the U.S. has a robust nonprofit lender network willing to meet the needs of these consumers. So if this is the case, why is consumer demand far exceeding the supply of these small dollar consumer loans? Credit Builders Alliance believes that a combination of technical assistance, loan capital, and small operating grants to our lender members will help to meet this demand. We call it our Products-in-a-Box initiative. Through the support of Wells Fargo, we are working to expand responsible and affordable small dollar consumer loan products through this initiative.
We believe this work will reduce the use of costly predatory products — such as those offered during the holiday season when people often turn to high-cost debt to pay for their holiday shopping. When this happens, it is quite common for next year’s holiday season to arrive before the past-season’s debt is even paid, further indebting low-income households.
This initiative will also increase access to asset-building opportunities by creating new avenues for credit building. Our approach of providing a combination of financial and technical support is key to supporting programs in the sustainable implementation of new products.
The challenge cannot be met in isolation. We believe that financial institutions, government officials, and community organizations need to all work together toward this common goal. A more financially stable America is one that pays dividends — not just to the consumer, but also to society.
Wishing you happy holidays and a prosperous new year.