The ordinary consumer is all too familiar with debt. American households, in fact, carry an average debt of $137,063 which consists mainly of mortgages, student loans, and credit card debts.
Considering that most people would have to repay these loans throughout their lifetimes, it does seem that debt is quite an integral part of human existence.
When we look at the history of U.S debt we can see that debt has acquired a negative stigma. It’s oftentimes associated with financial hardship regardless of whether it belongs to an individual person, business or a country.
However, debt isn’t all bad. When loans are used in a cautious manner, with a clear plan on how to pay them back and with a specific goal in mind, loans and financing could enable families and businesses to become more successful. What’s needed is a healthy mindset and attitude towards debt.
Technology has changed the way we approach a lot of things today including finance. People who are looking for loans are shifting away from traditional financial institutions and going instead to tech-driven lending companies.
The emergence of fintech and blockchain are making the loan experience streamlined and accessible to ordinary consumers, as well as to people who have issues with their credit score, businesses interested in alternative interest plans and people who are hesitant about taking loans from banks for whatever reason.
Here are three key ways technology is changing people’s approach to loans and credit.
Peers Over Institutions
Legitimate loans are typically sourced through banks and large lenders. This, however, has started to change over the past several years due to the emergence of peer-to-peer (P2P) lenders. P2P lenders pool together smaller amounts contributed by investors and lend the money out to consumers through digital platforms. Recently, P2P platforms like Lending Club and Prosper are making available loanable amounts of around $30,000 to $40,000 at competitive interest rates and with easier application processes.
Prosper's CEO David Kimball has said that, “Loans are used for a variety of purposes, such as a medical expenses or a special occasion. Many of our borrowers also use their loans for debt consolidation. Because Prosper has the efficiencies of a digital marketplace, we are often able to offer loans at a lower price than you may have for a revolving credit card."
With the availability of these alternatives, consumers are increasingly becoming more comfortable with the idea of relying on crowd funding for their financal needs. Some consumers who may have previously maxed out their credit cards to purchase big-ticket items or augment their cash flow are now flocking to online lenders to secure the funds needed, often, at much better rates. The variety of choices available online is good even for consumers who want to continue loaning money exclusively from banks as, with all these new options, there is new competition in an area previously exclusive to money lenders and bankers, and competition is always good for the client as it will drive down the rates for those continuing to loan from banks as well.
Credit Scores Matter Less
For a long time, US citizens’ financial well-being has largely been determined by their credit scores. Credit scores are derived from how often a person takes out loans and their ability to pay back what they owe. These scores often influence the willingness of lenders to approve new loans.
Unfortunately, credit scores don’t paint a full picture of a person’s financial capability. Millennials, for example, have had a difficult time dealing with their credit scores. Many entered the job market at the end of the recession, taking up low paying jobs and so, not paying back their student loans as required for their credit score to be unharmed. Because of this, many millennials typically have low credit scores. As of 2017, those aged 18-29 have an average score of just 652 which is lower than previous generations and has become an issue as they start settling down and are in need of loans for mortgages.
Fintech and blockchain, however, are starting to minimize the overall impact of credit scores in an effort to bring more financial inclusion. Tech-based lending platforms can utilize more complex algorithms and even artificial intelligence in order to take into account as much information as possible so as to get a clearer, more detailed picture of a person's creditworthiness. They can include factors such as: salary, purchasing history, educational attainment, and even social media activity. The information can help create a more comprehensive profile compared to just relying on credit history and utilization.
On some platforms, credit scores don’t even matter at all. SALT Lending, which allows borrowers to use crypto assets like Bitcoin and Ethereum tokens as collateral, do not even take credit scores into consideration.
The Drive to Decentralize
The centralized approach of financial institutions controlling the people using their systems financial activities is also being challenged. There is a growing distrust of large centralized organizations having key influence over people’s financial activities and information. Last year’s hack on Equifax that exposed more than 143 million consumer’s financial and personal information underscored the vulnerability in entrusting a single centralized authority with so much delicate information.
Decentralization has been key to blockchain’s growing appeal. Blockchain infrastructure is designed to be distributed so data isn’t stored in a single computer or data center but rather dispersed among many computers. The transparency and immutability the technology brings have also enabled the creation of decentralized applications where no one single entity can alter data or change a platform’s rules.
Blockchains can provide automation to lending through smart contracts and cryptocurrencies. Smart contracts, though actually just computer code to facilitate blockchain transactions, are increasingly being used as legally binding agreements. The use of cryptocurrencies also allows the transfer of value between peers without the need for intermediaries such as banks or escrow agents.
Age-Old Principles Apply
Technology is indeed changing the way consumers think about and manage debt. The rise of P2P and decentralized lending platforms have effectively challenged the power of centralized institutions over who gets ready access to loans and funds. Consumers worry less about managing their credit scores and just focus on their overall financial well-being.
However, despite these changes, it’s still important to keep in mind that the concept behind debt is still fundamentally the same. While loans and credit increase a person’s spending power, paying back debt is an obligation that has to be met. Fortunately, these fintech and blockchain platforms are also introducing new mechanisms that encourage consumers to pay back their loans. They feature a variety of means including automated smart contract triggers and even the involvement of collection agents through their ecosystems.
Wesley puts it quite nicely saying, “Credit and debt are as old as the wheel. Like that invention, both have been essential to human and economic progress. At the same time, debt has always carried risks. While the mechanics of finance has changed over history, the golden principle remains the same. Don’t spend what you won’t be able to repay. Otherwise, it may cost you everything.”
is founder and managing director at Hoffer Financial Consulting. Follow him on Twitter.