According to TransUnion's consumer credit prediction for 2023, serious delinquencies are increasing in several important loan categories even though demand is still robust. Moreover, TransUnion recently conducted a study that forecasts that more Americans will default on their loan payments in 2023.
Credit cards, unsecured personal loans, and vehicle loans are all experiencing an increase in delinquencies as consumer demand remains high despite price increases. Let’s look closely at trends and statistics in the personal lending market.
Personal Loans’ Popularity
Personal loans have grown in popularity over the past 10 years as more Americans use them quickly to obtain cash. As statistics from one of the leading online finance experts COMPACOM show, people frequently use personal loans to pay for personal needs like family holidays or events, consolidate current debt, and lower interest payments.
Personal loans are closed-end, uncollateralized sources of credit. They are often referred to as consumer loans. This means they don't require collateral, unlike mortgages and most vehicle loans. They also have fixed payments for a set period, unlike credit cards.
Investors have poured billions of dollars into the personal loan market over the past 15 years. These investments took the shape of direct loans, various bond arrangements, and venture capital. The once-personal lending market is not stagnant anymore. It expanded with double-digit growth rates thanks to this infusion of capital.
Although borrowing is as old as humanity, most recorded history has seen large-scale lending operations concentrating mostly on secured loans. Secured personal loans typically back assets like home mortgages and cars. The cause is clear. Few lenders are willing to take the chance of being left with a few worthless loan contracts. Lending became a profitable venture when collateral was requested. Unsecured loans were typically reserved for illegitimate and shadowy lenders who utilized alternative strategies to protect their investments.
New credit products like credit cards, payday loans, overdraft protection, bank lines of credit, and unsecured personal loans gained popularity after World War II.
Statistics of Applying for Loans
In the TransUnion study conducted with instant-cash-advance.us, 26% of participants stated they intended to refinance or apply for new credit in 2023.
These consumers are named:
- Credit cards (53%),
- Vehicle loans/lease (23%),
- Unsecured personal loans (22%),
- Mortgages (17%),
- New home equity lines of credit (14%),
- And refinance mortgages (14%),
- The rest intend to apply for various forms of credit.
Nevertheless, the economic environment is affecting credit ratings despite consumer confidence and plans to seek for credit. Financial experts say that as people struggle with inflation and rising rates, credit scores have been "slipping." They also add that lenders across various categories have been taking more subprime and near-prime customers than in the past to increase loan growth.
According to recent assessments on banking risk from the Office of the Comptroller of the Currency, the average household debt burden is still close to a 40-year low. The study said the median deposit balances have decreased in all income levels for the first time since the second quarter of 2020, even if consumers' overall cash buffers continue to be greater than usual.
Qualifying for a Personal Loan
The proportion of personal loans to subprime borrowers increased in 2022 compared to 2019. Does this imply that all lenders started lowering requirements in 2022? If they did, it would be great if this tendency would be transient. Rising risk aversion among lenders appears likely due to concerns about inflation and rising interest rates.
While bad-risk borrowers may have a harder time obtaining loans in the upcoming year, other borrowers who may have previously been considered bad risks may perform better than anticipated. This is because more complex tools than basic ones are used in emerging ways of risk assessment. Artificial intelligence is being used increasingly in the financial sector, which should lead to higher approval rates for competent applicants.
Artificial intelligence is increasingly being used in the finance sector. Businesses will increasingly employ machine learning to make more accurate decisions since machine learning-driven credit ratings significantly surpass traditional credit scores.
For instance, customers that use underwriting tools have experienced a 51% boost in personal loan acceptance rates with no increase in defaults. According to this development, personal loan approvals will increase, assuming that other market factors remain unchanged.
Loans Rates and Terms
The lender you apply with matters a lot when looking for a personal loan option. To the same borrower, lenders will provide a variety of annual percentage rates (APRs). Around 206,000 loan requests and offers for borrowers were examined between January and early December 2022 to determine how much borrowers can save by comparing multiple lenders.
It was discovered that there was an average 6.2 percentage point gap between the highest and lowest APR offers (across FICO scores and loan periods). This loan offers imply a steady income, so take note of that. This ensures that income variations do not obscure the impact of FICO ratings and loan terms.
The largest range of APR offers was 10.3 percentage points for borrowers with fair credit, and the smallest range was 3.1 percentage points for borrowers with perfect credit. This, at least, was accurate when all loan terms were considered.
Borrowers with fair credit might get the most from searching for the best rates when all loans are combined. As FICO scores decline, the loan APR distribution on average, widens. Therefore, the more you stand to earn from comparing several lenders, the lower your score.
Personal loans are frequently products with a credit component. This implies that the borrower's credit risk determines the cost of the loan. The FICO credit score, which has a range of 300 to 850, is the most popular. However, consider the following. Despite the widespread usage of FICO, not all lenders will charge the same interest rates to borrowers with identical credit scores. Depending on the lender, even the same persons receive different interest rates and terms. The huge diversity of APRs available to the same borrowers emphasizes how crucial it is to compare several lenders.
Effects of Inflation and Recession
It is clearly understood that large credit card lenders are concerned about the possibility of a recession and the anticipated increase in unemployment it would bring about. However, right now, inflation is the main concern.
Experts also state that they have discovered that unemployment primarily impacts consumers' capacity to manage debt. The effects, however, are "unique" to the workers who lose their jobs. Delinquency rates are projected to climb as more Americans contend with rising prices, higher interest rates, and general economic uncertainty.
Consumers with bad credit and limited resources were severely hurt by 2022's record-breaking inflation, which increased the delinquency rates for personal loans. At the start of 2022, more than 1.5% of all consumer loans made by commercial banks in the U.S. were past due. The personal loan default rate increased from 2.28% a year earlier to 3.37% as of the second quarter of 2022.
Rising delinquencies might first imply that consumers are having financial difficulties. The same Transunion poll did, however, also uncover considerable optimism over the US economy. According to the report, more than half of the Americans surveyed were upbeat about their financial situation over the coming year. The younger generations showed the most confidence.
This optimism might help to explain the recent growth in personal debt partially. Due to significant growth in credit card usage and mortgage balances in 2022, families raised their debt at the quickest rate in 15 years. According to the New York Fed, total credit card balances increased by more than 15% from the same time in 2021, the biggest yearly increase in more than 20 years.
The Bottom Line
Growth in consumer debt does not signal a problem for the economy or individual consumers. It rather shows that individuals are confident in the economy. As we've observed over the past year, the economic climate is unpredictable, and as a result, some borrowers may fall behind on their payments. Above all, consumers must use credit wisely by ensuring they can make their loan payments before taking on excessive debt in a time of rising interest rates.