Can a streamlined letter increase on-time loan payments?

Background

Redstone Federal Credit Union is Alabama’s largest credit union, serving almost 400,000 members across the state and in the Tennessee Valley. Redstone issues roughly 3,000 new loans to members each month, and many of those loans are repaid on time starting with the first payment. However, around 25% of loans are not paid by the due date, and 7% of loans result in a first payment default.

Loan defaults harm the member’s credit and result in additional expenses via late payment fees and interest. Loan defaults or late payments also are damaging at a broader level because they increase the cost of offering credit to other members. Increasing on-time first loan payments would benefit members and lower costs for Redstone.

Key Insights

There are several reasons why members may not make their first loan payment on time.

• The process of taking out a loan in itself can be difficult and overwhelming, leaving members confused as to when their payment is actually due.

• This confusion can be exacerbated by the official documentation that accompanies a credit union loan, which sometimes can be too dense and may confuse loan recipients.

Experiment

The Common Cents Lab worked with Redstone to create a Loan Information Letter to accompany the official loan note and disclosure form that clearly high- lighted a new loan recipient’s payment date and how to repay their loan with the goal of decreasing friction and reducing cognitive load. Although technical limitations precluded an experiment, the updated letter was sent out starting in Q2 of 2019.

Results

We compared the post-letter data to the same four months of the baseline 2016 data to account for possible seasonality. The updated letter is associated with an average decrease of about 1.5 days in time to pay across all loans (from about three days prior to the due date to a little less than five days prior.

These faster payment times across all loans translate into a greater proportion of the sample paying their loan on time. Redstone had a 16% reduction in late payments (from 25% to 21%). Fewer members required the five-day grace period or the reminder phone call. In an average month at Redstone, about 3,675 loans enter repayment. Before the updated letter, staffers called about 437 loan-holders (11.9%) each month to remind them of an outstanding first loan payment. With the updated letter, this number decreases to 386 calls (10.5%) per month. If an average call requires even five minutes of a staffer’s time, Redstone effectively gains 4.5 hours each month.

However, the letter seemed more effective for some types of loans. For example, those in the “other personal loan” category paid their loan 11.2 days before the due date when receiving the letter. Similarly, while the letter did not affect default rates for car loans or small-dollar loans, the letter was associated with a reduction in defaults for this same “other” loan category. While default rates for this group were low overall, people with “other” loan types are about half as likely to default on their loan when they receive the updated letter (2.4% default rate) compared to the baseline group (4.5% default rate).

Of note, this was a cross-sectional study conducting a pre/post analysis. As a result, we cannot rule out all alternative explanations, nor can we attribute all of these differences to the letter. It is possible that other programs happening at the credit union or other macro-level influences could also have impacted repayment rates over the same time period.

That said, the analysis does seem to suggest that Redstone was able to increase the proportion of loan recipients making early or on-time payments by adding a user-friendly, streamlined letter to their loan paperwork. On-time payments improve member financial well-being and reduce the burden on branch staff.

The letter seems to be an effective communication channel and further optimization should be tested. As Redstone and others continue to focus on repayment rates and reduced defaults, the effectiveness of just the letter could be increased by adding personalization or email reminders, helping members make a plan for repayment, or innovating ways that borrowers can better plan for repayment and align their payments with fluctuating income. We also recommend adding channels for reminders and communication, such as text messages, and innovating ways that borrowers can better plan for repayment and align their payments with fluctuating income.