I enjoy reading Bits About Money every once in a while. While long-winded, it often explains interesting elements of the current financial system. In this case, US consumer lending for large ticket items like windows.
The article does a pretty good job describing how we have managed to build up a very smooth machine for aligning incentives so that surprisingly large amounts of money can be loaned out in surprisingly short amounts of time. This, I think, is some of the famed efficiency of capital markets. Here are some of the most relevant bits:
In the 15-minute window between the loan being applied for and signed, software has conducted a four-way commercial negotiation between the window installer, the facilitating entity, the bank, and the capital provider. The loan contract is between the customer and the bank (again, it has to be, regs) but the capital provider is a specialist institution.
A bank which originates a loan might charge the facilitating entity an upfront fee-for-services, collect a servicing fee from the capital providers sliced out of the APR quoted to the customer, and of course retains actual economic interest in the loan… well, OK, a few hundred dollars of the loan, so that it can tell its regulators “No, really, we are lending money! It would be calumny to describe this situation as renting out a banking license!” Indicatively, that fee for services might look something like 1% of total loan volume, and the servicing fee might be 1% of the outstanding balance annually. (Mortgage servicing fees are about 0.25% but houses cost more than windows do and so you get an economy of scale. The servicing is essentially the same amount of work: you need a 1-800 number, lawyers on standby, the capability to receive checks, etc.)
So who is the capital provider and what are they getting? It will generally be a specialist fund, like say Sunlight Financial, whose name alludes to the solar business they got started in. You might naively assume “OK, 6.99% to the consumer, 1% servicing fee to the bank, so they get 5.99% APR on the loan, right?” I doubt that is the full calculation.
But: what if, like BNPLs, you could charge someone else a bit of money? Who benefits the most from this transaction? The window installer. So charge them for it. They’re clearly willing to pay something like 2.4% of the entire transaction size already, because they will happily let you buy windows with a credit card. So that’s the floor. A BNPL provider can charge Sephora something like 6% to sell lip gloss. That might be the ceiling. So can you get them to kick in… 5%? Probably.
So by default this is a lose-lose situation for the lender: if rates rise the value of the loan falls, if rates fall the loan very possibly gets repaid early. But with the origination fee from the installer, if rates fall and the loan is repaid early, the return on capital over the lifetime of the loan rises sharply.
If the loan is repaid after 7 years, which is approximately the average tenure in a house in the U.S., the real rate is about 8.15%. If it’s extinguished after a year, perhaps due to rates-related refinancing, about 12%.
These numbers start to sound attractive to credit funds, particularly when you have a repeatable process for generating them at 9 figure scales with independent credit quality.
As an additional wrinkle: is Sunlight the ultimate source of capital at risk? Well, if I were Sunlight, I might think of tapping the booming private credit market: borrow at a lower rate than I earn in expectation on my portfolio, collect the spread. If I were Apollo (such a natural brand to associate with sunlight, and among the world’s largest credit funds), I might buy an insurer or figure out how to get retail investors private credit exposure to fund billions of dollars to anyone who creates a loan origination engine with demonstrable credit quality.
I read the whole thing as a demonstration of the way an advanced market society can spread out the cost of producing something like installed windows, assigning just exactly the amount of cost that each participant in the economy is willing to pay to make sure new windows happens. It's pretty cool!