Revenge of the Installment Loan

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Image by viewerblur, used via Creative Commons

The Internet is finally disrupting the last holdout in finance: Unsecured loans to consumers. Frankly, it’s about time. Consumers have been able to manage checking accounts, pay bills and buy stocks online for over a decade, but until recently, they have had no real way to use the Internet to take out a traditional unsecured loan and pay a competitive interest rate. The most convenient option has been the credit card, which consumers have adopted widely — but at a cost.

Surely you have heard of America’s rising credit card debt — now averaging about $7,000 per household, or $800 billion nationally — but have you ever noticed that credit card rates are the only interest rates that have not declined significantly in the last 30 years? At the same time, banks have increasingly pulled away from the costly, manual process of underwriting unsecured consumer loans and have marketed credit cards instead. For decades, credit card debt grew enormously while traditional consumer loans with fixed interest rates and payment terms withered away. This has left consumers paying high interest rates on credit card debt, despite overall interest rates that are at the lowest levels in two generations.

Thankfully, this is changing, with real benefits to both consumers and small businesses. Consumers with good credit profiles can now take out unsecured three-year loans of $5,000, $10,000 or even $20,000 over the Internet. Instead of paying credit card interest rates, they can pay interest rates for these unsecured loans ranging as low as 6 percent. Why? Because the innovative companies that facilitate these kinds of unsecured loans do all of their marketing and underwriting over the Internet and can operate in a much lower cost structure than traditional lenders. The same goes for loans to credit-worthy small business owners, who can use the Internet to take out fixed term unsecured loans of $50,000 or higher and pay highly competitive interest rates — again because the new firms that market to and underwrite the small business owners can do so far more cost effectively over the Internet.

The companies that are leading the resurgence of fixed-rate lending include firms like Lending Club (disclosure: Lending Club is an NVP portfolio company), Kabbage and On Deck Capital, all of which make responsible borrowing by consumers and small businesses far more cost effective over the Internet.

Not only are interest rates shrinking, but customer experience is improving. Internet-centric financial companies are changing loan applications into a faster, more efficient and more transparent process. Online access makes the application and approval processes inherently streamlined and automated. For example, Kabbage boasts a seven-minute loan turnaround; On Deck Capital posts clear-cut eligibility requirements online; and the Lending Club experience is positive enough to result in a Net Promoter score in the 70s — higher than any class of financial services institution including credit unions and community banks.

The impact of these online lending sites is already here. Unsecured consumer loans via peer-to-peer lending sites like Lending Club tripled last year to $1 billion, growing much faster than total credit card debt and overall small business lending. Consumers should hope that these companies not only continue to drive rapid growth of unsecured installment loans, but also start to impact other lending products such as student loans, which right now are at over $1 trillion nationally, auto loans ($770 billion nationally), and even mortgages ($8.48 trillion nationally). Transforming these products into more efficient vehicles for borrowing will have a major impact on American consumers in small businesses as well as the American economy.

As consumers and small business owners become increasingly aware of these previously unavailable, highly attractive Internet options for fixed-payment, fixed-term loans, the volume will continue to explode. Watch out, credit cards: Installment loans are taking revenge.

Jeff joined Norwest Venture Partners in 2004 and focuses on investments in the Internet, consumer and software arenas. He currently serves on the boards of Badgeville, deCarta, Extole, InfoArmy, Lending Club, RetailMeNot, SocialVibe, The Echo Nest and Turn. Jeff’s past investments include Admeld (acquired by Google), Jigsaw (acquired by Salesforce.com), Tuvox (acquired by West Interactive), and he was a board observer at Cast Iron Systems (acquired by IBM).


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