Last year, the total number of unsecured personal loans in the U.S. rose to nearly 29 million, a 7.1% increase from the previous year. The average loan balance jumped to $19,402, up 6.3% from the previous year, according to Experian. A major driving factor behind this rapid rise is the number of fintech companies partnering with banks and other nonbank financial companies to provide hassle-free loans to borrowers.
The nearly $200 billion in unsecured loans is just a fraction of the $12 trillion in mortgage debt that Americans will carry in 2024. Unlike their unsecured counterparts, however, mortgage loans are collateral-backed and have a definite regulatory landscape, protecting both the borrower and lender.
“The increase in unsecured loans could greatly impact the credit ratings
of millions of people, potentially hindering their future homeownership prospects.”
Moreover, the increase in unsecured loans could greatly impact the credit ratings of millions of people, potentially hindering their future homeownership prospects. Thus, there is an immediate need to establish a strict regulatory landscape to control the growth of unsecured loans, ensure compliance, protect borrowers’ interests, maintain order within markets and more.
Accessible credit
Unsecured lending refers to loans that do not have any collateral requirements. Lenders determine the eligibility of borrowers to pay back the loan by assessing various factors, such as credit score, income, current debt, capital in savings or investment accounts, etc.
They usually come with higher risk as, unlike a mortgage loan, the lenders do not have any security. There are various forms of unsecured lending, with personal loans as the most common. They allow borrowers to use the loan amount for multiple purposes, such as home renovations, medical emergencies, wedding expenses, travel and personal expenses.
Credit cards also fall in this category. Other types of lending that fall into unsecured loans include some business loans, lines of credit through a bank or credit union and even student loans.
Some features of unsecured lending include higher interest rates compared to secured loans, based upon the potential risk for the lender. Unsecured loans are often faster to process, have shorter repayment terms, usually ranging from five to seven years, and lower borrowing limits.
Regulatory call
Creating a strict regulatory landscape for unsecured lending is a must for several reasons. It can create a measured approach for lending, thereby fortifying the lenders’ loss-absorbing buffers.
Regulatory measures can also help check the unhindered expansion of unsecured credit as well as reduce risks, especially for nonbank financial companies. Additionally, they will help calibrate and stabilize growth, potentially reducing non-performing assets.
Apart from this, setting up a regulatory landscape for unsecured lending can lead to a more secure environment, encouraging lenders to allocate more capital to this segment. Furthermore, it will enable the authorities to safeguard the interests of consumers, contributing to overall economic growth.
This stands in stark contrast to the mortgage market, which is regulated by several laws that are enforced by agencies on both the state and federal levels. These laws aim to protect borrowers from predatory and deceptive lending practices, along with safeguarding the mortgage segment from financial risk.
Looming risk
By 2026, the global unsecured lending market is predicted to reach $5.39 trillion, indicating a 9.5% compound annual growth rate. A major driving factor behind these increasing numbers is the advent of digital lending platforms, which make unsecured credit more accessible to the underbanked and unbanked segments.
For instance, peer-to-peer lending platforms allow borrowers to connect directly with investors and obtain unsecured loans. This provides borrowers with quick access to funds without any collateral requirements, while lenders gain access to a new asset class.
Moreover, mobile banking platforms nowadays use machine learning algorithms to assess lenders’ creditworthiness. Thus, loan applications and processing become much faster, enabling borrowers to access credit with ease.
On one hand, these new platforms may improve the accessibility of credit to borrowers. This may cause a potential rise in defaults with more and more of these loans non-performing, however. Hence, a proper regulatory framework is a must for supervising the activities of such platforms to prevent any adverse economic effects.
Potential defaults
Unsecured loans, by nature, do not require collateral, which means they often have higher interest rates, increasing the risk for lenders. Hence, the surge in unsecured loans could have increased implications for borrowers’ credit ratings.
As more consumers take these high-interest loans, the likelihood of defaults rises, which can adversely affect their credit scores in future. There can be several disadvantages of a declining credit score. Poor credit scoring can lead to higher interest rates on future loans, which means borrowing will be more expensive in the future.
A low credit score decreases the chance of securing loans, and borrowers might face difficulties repaying them in the future. As credit scores deteriorate, borrowers’ ability to qualify for mortgage loans can be compromised, delaying or preventing homeownership for some borrowers who might have to remain renters longer.
Assessment models
There has been a significant rise in fintech companies and digital lending platforms in recent years. They usually target the unbanked sectors and facilitate instant disbursal of collateral-free loans. In the effort to make credit more easily available, these companies often overlook the borrower’s ability to repay the loan, resulting in rising defaults, especially in the high-risk, low-ticket segment.
In the future, fintech companies likely will develop new creditworthiness assessment models that consider several aspects besides credit scores. Another prediction will be the rise of lending platforms for small- and medium-sized businesses that collect first-party data from platforms like Shopify, BigCommerce, Shift4Shop, etc., and partnering them with financial data from account aggregators to facilitate loan disbursement and repayment collection.
The emergence of seed platforms to provide alternate financing to startups can help them get the much-needed capital for growing their operations. This will enable them to focus more on developing their offerings than worrying about getting credit from banks.
Unique challenges
With the increase in demand for unsecured lending via digital platforms, lenders are facing some unique challenges. Digital lending requires super-fast loan processing, high accuracy and 24/7 service availability.
Fintech companies will have several opportunities to increase their market share by promoting financial inclusion in a more economically secure environment. Also, these entities are revolutionizing the real estate mortgage market by simplifying, speeding up and automating the overall mortgage application and underwriting processes. To do so, they need to develop digital-first business models, which will require integrating products from reputed technology providers. These platforms can provide multiple payment methods, which can help companies seamlessly disburse, collect and reconcile payments in real-time.
