Most consumers can remember when they received their first loan. Sometimes it was a credit card while a student. Perhaps it was an auto loan. Or maybe it was just to take advantage of a unique opportunity that would not have been possible living paycheck to paycheck and just starting out married life.
Lending is empowering. Whether the purpose is to obtain transportation, invest in one’s education or move into a first home, loans enable members to realize ambitions or to participate in economic life more fully.
Credit is the driving force behind “credit unions.” While it is a cliché to say that no one can borrow until someone saves, lending drives the credit union economic engine. While many of the other indicators of growth have slowed in the past three years, loan growth has continued to expand at double-digit rates. Not just credit unions and their members, but indeed much of the economy relies on credit to grow.
Today, credit unions are serving over 43 million borrowers with total loans at midyear of $487.5 billion. And there are unused lines of credit that provide additional capacity totaling $110 billion.
But some assert that loans are just another commodity product with most members merely seeking the best rate. These observers ask if there really is a need for a credit union option in an economy where lenders shower households with credit offers.
The Credit Union Opportunity
Is consumer and mortgage lending just another commodity service? Can value be added through price and other factors that differentiate the credit union model?
Data from CUNA’s National Member Survey suggest that credit unions hold only a fraction of a typical household’s outstanding loans. While the average household loan balance (excluding mortgages) at credit unions is $6,872, the balance outside the credit union for the same family is $12,621. That is, the credit union share of a typical credit union household’s loans is only 35%.
The data suggest that there is a challenge and an opportunity here. In the survey, market shares for specific loan products range from a high of 30% for member households with a credit union auto loan to 10% for households that use the credit union for a first mortgage.
Understanding Members’ Needs
Certainly price matters, and in many situations credit unions offer a better deal. But often members, as shown by the 35% share of wallet, do not know this. Mountain America FCU has developed a Rescue Loan program as a way to inform members about opportunities to lower their rates on loans at other institutions by refinancing with the credit union.
The program’s origins were in indirect lending. New members were called to introduce the credit union and confirm their satisfaction with the auto loan. During the call, if appropriate, the member was informed about the savings on other loans that could be refinanced by the credit union. These outbound calls were so successful that the effort was extended to the branches. Current volume from both sources is almost $50 million per year.
Spokane Teachers Credit Union developed a line of credit for its educators that permitted loan payment moratoriums during the summer when teachers were not receiving regular pay. Many teacher credit unions have developed similar features to meet nine-month pay schedules.
But the credit union took the idea a step further. A number of its members work in Alaska’s Bering Straits supporting gas and oil exploration. They borrow to buy generators, which are the primary source of power in the Arctic. However, weather conditions prevent working during winter months. The credit union, using the teacher model, offers skip-payment loans during these periods of no or low income.
Changing the Marketplace
Sometimes credit unions enter markets and find that existing lending practices tend to exploit rather than serve borrowers. In government guaranteed student lending, lenders were permitted to assess up-front fees. When USC Credit Union became a major lender on campus, it eliminated all such fees. University Credit Union in Austin, Texas, saw the model and similarly changed its program. Today, on both campuses the majority of lenders have followed the credit union model and eliminated the up-front fees of up to 3% which were taken out of the loan advance.
A similar situation is occurring in the reverse mortgage market, which has jumped in volume by 77% in fiscal 2006 according to the National Reverse Mortgage Lending Association. But up-front fees to establish the draws against the equity can total as much as 8% of a home’s value. Two percent of this goes to the government to insure the mortgage, 1-2% goes to the lender, and the rest pays for closing costs. So just to establish the “line of credit” could result in a substantial payment.
Suncoast Schools FCU has had a reverse mortgage program since 1987. There are no annual fees on the loan, only a one-time $200 processing fee plus closing costs. To date, Suncoast has had no charge-offs from the program and currently has 35 outstanding loans. Once again credit unions are restructuring the accepted terms in a market—an action no single borrower could ever accomplish by comparison shopping.
Over the past decade, advances against paychecks have become a widespread and extremely profitable business. According to the Center for Responsible Lending, there are over 22,000 payday loan shops nationwide costing American families $3.4 billion annually. Terms are often set as a fee against a loan amount such as $15 per $100 of borrowing, to be repaid in two weeks when the customer brings his next paycheck. On an APR basis these loans can result in rates in the 400-800% range.
Payday loans meet an important need of substantial numbers of employed persons who live on the cash flow of one paycheck to the next. Sometimes these are unbanked individuals. But a Nevada credit union that surveyed its members said that 25% had used a payday lender within the last year and of these over 30% had a college education.
Credit unions are using a variety of means to better serve this market. Some have adopted a payday lending lite approach. They follow many of the same business models, but by using the existing branch infrastructure they can lower the advance terms significantly.
In Ohio, Wright-Patt CU and 18 other credit unions have set up a nationwide CUSO. This CUSO established “StretchPay,” a salary advance program to compete with payday lenders. “StretchPay” charges an annual fee of $35 for a line of credit that has an APR of 18%. The fee goes to the CUSO as a loss pool for all credit unions using the program. Ninety percent of any losses are covered from the pool with the credit union responsible for the balance. To date, the CUSO has funded 4,000 loans with outstanding balances of nearly $1 million.
In a recent speech, Shelia Bair, the new Chair of the FDIC, cited Pentagon FCU’s payday loan alternative program as one that other financial institutions should try to emulate. Pentagon’s Asset Recovery Kit (ARK), offered through its foundation, provides members a loan up to $500 or 80% of their net pay with only a $6 flat fee and no credit report. To get the loan, the member must agree to financial counseling, which includes contacting the member’s creditors and creating a roadmap to financial health.
Supporting Societal Goals
Credit unions are becoming more active in using loans to highlight critical issues for the economy. One of these is our energy dependence on foreign sources—what the President has called an economic addiction. State Employees CU (NC) has created a green mortgage program as part of its response to a problem that members perceive acutely when the cost of gas approaches $3.00 per gallon. The credit union is creating energy awareness in its lending for new or existing homes. For any home validated by a third party as meeting the minimum requirements of the 2006 International Energy Conservation Code, the credit union caps its two-year standard ARM origination fee at $350. Moreover, members may qualify for 100% financing and the credit union follows more flexible underwriting guidelines.
In addition to promoting energy conservation, the loans help to offset part of the higher construction costs associated with Energy Star homes. In essence, the credit union is helping members make a better long-term choice even though this decision may include a higher short-term cost.
Sound Credit Union in Tacoma, Wash., follows the same green strategy with auto loans. For hybrid car loans, the credit union reduces its rates 50 basis points. On its website all qualifying cars are listed along with information on how hybrid cars work and comparisons with standard engine options.
More than Price
Lending not only helps members reach for new opportunities, but the cooperative way in which credit unions approach markets can change the way business is done. As a cooperative, members with savings are enabling the credit union to influence and accomplish lending practices that have broad impact for all consumers. While a well-off member might be able to negotiate a better student or reverse mortgage loan, an individual can rarely have the impact of an institution that uses collective resources to change market practices.
Innovation is an important driver of differentiation in crowded financial markets. Innovation requires creative responses to member needs, not merely trying to do more efficiently what current lenders provide. Credit unions today are changing the way lending is done in market after market: clean credit card programs, no-fee student loans, low- and no-cost mortgage refinancing, simple interest auto loans, responsible short- term unsecured lines of credit—just to name a few areas.
Credit unions are applying their imagination to new concepts like the Ratchet Mortgage and the One account. Because credit unions place the member’s interests first, the opportunities in lending will always be more than price. The cost of credit does matter, but more important is credit that enhances a member’s well-being rather than exploiting his or her circumstances. With the member’s needs foremost, the credit granting role of credit unions can continue to be a critical source of real competitive advantage.