I often get asked whether rising interest rates or economic downturns negatively affect our lending. It’s a good question and one that, logically, you would think would negatively affect consumer lending.
As the Federal Reserve pushes up the fed funds rate, thus increasing short term (and longer maturity) treasury yields, the cost of borrowing for personal loans must increase as well. Why? The cost for lenders to secure capital has increased. Therefore, they must pass higher borrowing costs along to the consumer in the form of higher loan rates.
People are quick to point to the mortgage loan industry and how loans have significantly decreased over the last several months. However, loans for mortgages and loans for consumers at the point of sale are vastly different.
Let’s take a look at why this is.
Mortgage loans are inherently long-term loans, with the exception of adjustable rate mortgage loans (ARMs). They are typically tied to the 10 Year Treasury rate, not the 1 or 2 Year Treasury rates. When mortgage rates go down or stay low, this prompts holders of higher rate mortgages to want to refinance their mortgage into a lower rate loan. Higher rates also decrease affordability of a mortgage, given a mortgage is by far the largest debt a consumer will incur in their lifetime.
On the other hand, a personal loan taken out at the point of sale has a much different dynamic. These loans are much smaller and typically have a short duration – two to five years. A two or three percentage swing to the upside in APR has a far lower impact on the overall cost of the loan than a long duration loan, such as a mortgage.
In addition, since merchants or medical/dental practices are on the other end of the loan transaction at the point of sale, they will oftentimes offer 0% interest financing or buy-down the rate to encourage the sale (or a higher sale ticket) and pay the lender for the privilege of this type of financing. In this way, a merchant or practice can protect the consumer or patient from any effect of a rise in interest rates.
0% interest or rate buy-down promotions work for the consumer in both good or bad economic times. At point-of-sale, they will typically not experience the rate variance that is happening behind the scenes between lender and merchant.
But, what about the borrower’s ability to pay during swings in the economy?
I like to say, “When times are good, people will borrow feeling confident they can do so with their earning power. When times are tough, people will borrow out of necessity, in order to make the purchase they need now and be able to pay it back over time.”
Lending is the grease to the economy’s skids! If you’re a merchant, medical/dental practice, or automotive repair shop with price tags that are in the thousands of dollars, having a good financing program and platform is key to winning sales you will otherwise lose without one.