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Consumer Credit

Consumer Credit Should Be Favorable for the Borrower

We all live within a credit system that was not made for us. Rather, it functions as an investment tool for organizations that lend. Banks charge exorbitant interest rates for unsecured credit (on average, banks charge consumers a 10.60% APR for unsecured loans, while they only pay consumers 0.75% APR for certificates of deposit). Instead of seeing debt as a tool for financial mobility, there is a common belief that “all debt is bad” because of the toxicity in the current consumer lending environment. Lenders use credit scores to predict the highest interest rate that a borrower will reluctantly accept rather than to price the borrower appropriately for their risk level. That model does not give rise to consumer friendly products. At Earnest, we are breaking that norm by giving credit to financially responsible people at a rate they have earned. (You can read more about this in our CEO’s blog post.)

We all know that couple that decided to wait an extra year to get married so they could afford to invite everyone they wanted to their wedding. If they saved $300 per month for a year in order to afford a larger wedding, wouldn’t it make sense to give them a $3,500 loan for a wedding today and let them use the $300 per month earmarked for the wedding to pay back the loan? This is what Earnest is doing. That $300 per month for a 1 year loan of $3,500 is the rate Earnest is charging. With a 5.5% APR and equal monthly payments for a year, the total interest that accrues is only about 3% of the principal borrowed amount: roughly $105 in interest for a $3,500 loan (try moving the slider on the Earnest homepage). It’s even less if the loan is paid earlier than scheduled (our first client to complete a loan with us paid only $9.04 of interest on a $3,000 loan by paying back early).

A loan is simply a tool to smooth out your budget. It does this by transforming large lump sum costs into predictable and manageable payments. Debt can be used to make significant personal investments that enable upward social and economic mobility. Although these use cases are common and important events in people’s lives, unsecured loans are less common than secured loans (like mortgages or auto loans where property will be used as collateral if the borrower defaults). Unsecured loans are unique in that they require the lender to trust that the borrower will pay back the loan. As far as we can tell today’s financial institutions seem to have lost that ability to trust.

At Earnest, we are giving people the opportunity to share their financial information with us so we can see that a client’s budget makes sense for the amount requested. The product we are offering is at a great rate and is built specifically for Earnest clients who have demonstrated that they are financially responsible. We aren’t interested in what you would be willing to pay in interest, but instead, we want to let you demonstrate to us that you are financially responsible and have earned the interest rate that we offer. We are providing a credit option that is flexible to work with your schedule. We have minimum scheduled payments to keep you on track. We have no prepayment penalties, no origination fees, and no hidden fees of any kind. If you find a loan with better terms, you could (and should) take that loan and use it to pay off the loan you have with us at absolutely no extra cost to you (no prepayment penalties). We are excited to build a relationship with you based on trust and transparency as we reshape the financial system.

— Austen Head, Founding Data Scientist

Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.