How to Value the True Cost of a Loan
How should we measure the true value of a loan on consumers’ lives? Lower blood pressure, for the anxiety and stress saved? The dollar amount of an additional payday, because someone could afford to repair the car and get to work? The quality of life achieved for being able to cover that unexpected medical expense?
Short-term, small-dollar credit is essential for millions of Americans. Its benefits are undoubtedly hard to quantify. Its costs? Well, measuring those just got a little bit easier.
In 2015, Oportun, a community development financial institution (CDFI), sought to understand just how expensive its loans are compared to other forms of credit that its customers might use. It recognized that the Annual Percentage Rate (APR) as a sole measurement of loan quality was not accurate. Oportun turned to Financial Health Network.
Read more about how millions of consumers’ lives might one day be positively impacted because of the gumption to ask some simple questions.
Read the full transcript of our interview with Sarah Livnat, Senior Director of Community and Government Relations at Oportun.
Sarah Livnat: I work for Oportun, which is a provider of affordable and credit building loans for low-income, Hispanic communities in the United States. We’re also a Community Development Financial Institution.
We were interested in working with Financial Health Network to help us understand how much our customers were saving in terms of interest and fees by taking a loan from us versus going to other widely available products like payday, auto-title, pawn.
Can you describe Financial Health Network’s “True Cost of a Loan” Model?
SL: Financial Health Network created a model for us which measures and compares the amount that customers actually pay in total, for different types of small dollar products like payday, auto-title, installment loans and then also Oportun. And then they compared them and took into account actual real life incomes and available cash flows of consumers. To be able to really do an apples-to-apples comparison of what the true cost impact was to the consumer at the end of the day.
Financial Health Network was the perfect partner. They really understand consumer attitudes and needs for consumer credit. They also have a really robust understanding of the marketplace and the types of options that are available to consumers.
How much are your customers saving by using Oportun loans?
SL: Financial Health Network helped us do the math, and understanding how we have helped each and every customer save money on their loan by going with Oportun versus the more expensive product. And in total, over the, at that point, nine years that we’ve been doing business, we have saved customers over $340 million in interest and fees.
The result is that we now have the data that actually shows that other products are, on average three times more expensive, and in some cases, seven times more expensive than the product that we provide our customers.
How are you structuring your loans for consumer success as compared to your competitors?
SL: What we saw is that these products like payday and auto-title are marketed as products that you pay back in let’s say, two to four weeks but in actuality, it takes consumers many months to pay those back. Sometimes five to six months, or even longer. And in comparison, a product like ours, which already gives a consumer that much time, if not more, to pay back, is a much more successful and lower cost product for them.
What should providers take away from this story?
SL: We’d love to see other financial services company take a similar approach in understanding their impact of their high-quality products on low to moderate income communities… Really looking at it from the customer’s perspective and understanding their day-to-day costs, expenses, and what kinds of available cash flow and disposable income they have to put towards these types of products is very important.
We encourage other financial services providers to use this type of model that Financial Health Network did for us. I think it’s an excellent way to really understand the true impact, from a customer’s perspective, about how their products are helping consumers save money.
Why should policymakers pay attention to the “True Cost of a Loan”?
SL: It’s important for policy makers to learn about this model because when evaluating the affordability of a loan, it’s important to look beyond the APR. This model allows them to do that. It allows them to look from a consumer’s perspective, what they can truly afford.