Magazine article American Banker

Lenders Using Carrot Rather Than Stick to Get Prompt Payment

Magazine article American Banker

Lenders Using Carrot Rather Than Stick to Get Prompt Payment

Article excerpt

Finance companies are trying a new tack to get subprime borrowers to pay on time: positive reinforcement.

Associates First Capital Corp., Dallas, announced a program Monday that grants moderate- to low-income borrowers lower interest rates once they pay on time for 12 months in a row.

And Money Store, a unit of First Union Corp., has had a similar program since July 1998.

Though lenders said adding such features to loans may be hard for brokers and loan investors to get used to, rewarding good behavior may be preferable in the long run to the traditional approach of hammering delinquent borrowers with late fees, said Jennifer Scutti, a Prudential Securities analyst.

She acknowledged that the lower rates might appear to cut into the profitability of the loans, but added, "If you are rewarding people for paying on time, you don't need as large of a reserve for loan losses.

"If people pay their bills on time, you do not need as many people in collections and have the ease of not going through the back-office end of it," she said.

But Robert Miles, the nonprime manager at National City Corp., Cleveland, said offers like Money Store's and Associates' are difficult to manage internally.

"These kinds of programs require a lot of servicing. And conversely, what do you do if a customer doesn't make good on the payments? Punish them instead of rewarding them?" Mr. Miles said.

By contrast, National City has a five-year renewal program where subprime borrowers are evaluated individually and extended a line of credit at a better rate the next time around if they have made timely payments, he said.

William Acheson, a managing director at GMAC-RFC, Minneapolis, the home equity arm of GMAC Mortgage, said the company offers incentives on its adjustable-rate mortgages, but brokers do not like to deal in loans that carry them. …

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