A new program being offered by some credit unions lets borrowers take out small loans and build up a savings account as they repay their debts. The program is proposed as a way to help low- and moderate-income earners who struggle to save, while also repairing or establishing credit.
"It's a good alternative to a predatory lender," says Pamela Owens, vice president with the National Federation of Community Development Credit Unions. The New York-based financial institution association developed the "Borrow and Save" program and tested it with four member institutions starting in 2011. In 2013, a dozen credit unions took part in a two-year pilot study.
The typical loan made in the pilot carried an interest rate of 18%, according to the federation. So-called predatory lenders including check cashing shops, payday lenders and auto title lenders may charge fees and interest rates amounting to as much as 400%, according to Filene Research Institute, a non-profit consumer finance think tank in Madison, Wis. that helped fund the pilot.
Borrow and Save loans are usually less than $3,000. Borrowers make regular monthly payments for three months to a year. Part of each payment covers principal and interest. Another portion goes into a savings account that is frozen until the loan is paid off. When the last payment is made, the savings account is unfrozen and borrowers also have savings amounting to as much as half the loan amount.
For years, some credit unions have made small, low-cost loans to income- and credit-challenged borrowers as payday lender alternatives. The saving component makes this different, says George Hofheimer, chief knowledge officer with Filene Research Institute.
"The unique feature was linking in the forced savings components for the first time, so that next time they have a need, they may have a saving bucket to dip into," Hofheimer said.
The test showed the loans are modestly profitable for many credit unions, and were easy for consumers to tap. The average Borrow and Save customer had a credit score of 580 or so. That is below what most traditional lenders look for. Other borrowers had no credit score at all. However, the Borrow and Save lenders weren't primarily relying on scores.
Instead, they made sure payments were no more than 5% of borrowers' paychecks. Beyond that, they required identification, proof of income and rent and utility bills with a current address. Borrowers couldn't take out more than one loan at a time, or more than three a year.
Freedom First Credit Union in Roanoke, Va., has done similar loans since 2012. Dave Prosser, senior vice president of Freedom First, said Borrow and Save loans have benefited borrowers, occasionally in a striking fashion. Some have used accumulated savings and improved credit scores to return later for larger automobile loans and even mortgages.
"We've been able to track people who started with Borrow and Save and have become homeowners as a result," Prosser said.
Proponents of the idea acknowledge that it is counter-intuitive to pair borrowing with saving. And more than 90% of credit unions asked to participate in the pilot decline, according to Filene Research Institute's report.
But lending and borrowing are both familiar activities for financial institutions. And the Filene report said that of 3,000 customers over two years, borrowing nearly $3 million in total, only about 10% failed to pay back loans.
Now that the pilot has appeared successful for both lenders and participants, there is hope that the product or one like it may become more widely available. Administrators and pilot participants are developing materials to help other credit unions and possibly community banks roll out similar offerings. "We actually have had calls from other credit unions that are very interested in adopting the program," says Owens.