There should not be insane profits on the backs of people who can least afford it. – Ginna Green
If you look at payday lending stores like a deadly disease, then the letter was like an announcement of a new virus mutation.
The letter, signed by 250 consumer advocate groups, charities, religious organizations and policy think tanks, called on federal regulators to stop payday lending by banks, calling it "inherently dangerous."
Banks offering products similar to payday loans are not, of course, deadly viruses or mutations. They are not even particularly new (Wells Fargo has offered its "Direct Deposit Advance" since 1994 for example). But consumer advocates such as Ginna Green, a spokeswoman for the Center for Responsible Lending, are worried more banks will look to payday type loans with triple-digit annual percentage rates — all in an attempt to help replace income they lost when the federal government clamped down on high fees on credit cards and debit cards.
"There should not be insane profits on the backs of people who can least afford it," Green said. "The fact that a bank could come in and charge the same amount of interest as the payday lending place in the gaudy building on the corner is unacceptable to me."
If it looks like a duck
A study by the Center for Responsible Lending looked at the "checking account advances" or "direct deposit advances" that several banks are offering. CRL wanted to see how similar the advances were to the storefront payday loans.
A traditional payday loans is a short-term loan that is due in full at the borrower's next payday. But many who take out these loans are unable to pay it in full with their next paycheck, so they either roll the loan into another payday loan or pay it off and take out a new payday loan. Either way, they pay the new fee and end up trapped in a debt cycle and carry an annual interest rate averaging 417 percent.
Although the banks do not call their advances "payday loans," Green said the effect is the same. "If it looks like a duck and quacks like a duck," she said. "It looks just like a payday loan. It has triple-digit APRs. You have to pay it back within a month — some times within two weeks. That is a payday loan offered by a bank."
Other banks that offer the advances are US Bank, Regions, Guaranty Bank and Fifth Third Bank. Sometimes the banks are able to offer the advances in states that otherwise prohibit or restrict payday loan stores.
The study by CRL found that, on average, the bank payday loans carry an APR of 365 percent based on the typical loan of 10 days. That is a $10 fee for every $100 borrowed. The study also found that people who take out the bank payday loans are in debt, on average, for 175 days per year — repeatedly taking out the short-term loans.
And almost one-quarter of all bank payday loan borrowers are Social Security recipients.
Payday lending stores use post-dated checks to access funds in a borrower's checking account. Banks, however, have the advantage of putting themselves first in line to collect their fees and loans automatically when the direct deposit comes in.
"With the bank payday loans there is not a cushion," Green said, "where a storefront payday loan place might cash the check, they might not. With bank payday, it is going to be deducted as soon as your paycheck comes through the door."
Some banks even go so far as to automatically overdraw an account if the direct deposit didn't have enough to pay off the advance. This means the resulting overdraw fees are added on top of the advance fee.
Nathalie Martin, a professor at University of New Mexico's School of Law and an expert on consumer law, said some people go to the storefront payday lenders and borrow money to pay off the bank advances — thus expanding the cycle of debt.
Asking for regulation
The letter sent by advocates to the federal regulators asked those regulators to move quickly to stop the use of the loans among banks from becoming more widespread. "Ultimately, payday loans erode the assets of bank customers and, rather than promote savings, make checking accounts unsafe for many customers," the letter stated. "They lead to uncollected debt, bank account closures and greater numbers of unbanked Americans. All of these outcomes are inconsistent with consumer protection and harm the safety and soundness of financial institutions."
Even before the letter came out in late February, the head of the Consumer Financial Protection Bureau, Richard Cordray, said it has the authority to examine payday lenders and banks that offer deposit advances. "We have already begun examining the banks," he said, "and we will be paying close attention to deposit advance products at the banks that offer them."
The Consumer Financial Protection Bureau even has a webpage for complaints about banks, credit unions, payday lenders, debt collectors and other financial service companies at www.ConsumerFinance.gov/complaint.
Market determines rates
But not everyone thinks payday loans are a bad thing — or that banks offering the loans are engaged in something that is inherently dangerous. Richard W. Evans, an assistant professor of economics at BYU, said the high fees charged for payday loans are necessary. "I think the evidence I found is that these high interest rates in payday lending, of 400 and 500 percent APR, these are market determined interest rates," he said.
The loans are very risky for regular payday lenders. The low dollar amount of the loans also factor in. Evans said, for example, a $100 loan might take an hour and a half of an employee's time to process from start to finish. If they are being paid $8 an hour, that is $12 just to service the loan. A $15 charge for a $100 loan comes out to about a 450 percent APR.
But Evans (who received a research grant in 2010 from Consumer Credit Research Foundation, which publishes research supporting the payday lending industry) doesn't like even using APR for payday loans.
"A 450 percent APR is like quoting a hotel room by its annual price," Evans said. "It is like saying, 'This hotel room costs $365,000 a year.'"
Green, however, said looking at the APR is necessary. "The whole purpose of APR was designed so that people would be able to compare the cost of credit," she said. "A lot of loans don't go out for a year. Some loans go for 30 or some go for five. Very few loans are one year, but the reason why we calculate an APR is so we can do an apples-to-apples comparison about the cost of credit."
Evans said it is less risky for a bank to get involved in payday lending. Banks know a lot about their customers, he said. It has a list of every transaction. It knows the income history. It knows how often a person is paid. It knows how a person spends their money. It can pull credit reports.
Payday lenders, on the other hand, don't have any of that. People just walk in off the street. "Banks have so much more information," Evans said. "And they have an ongoing relationship with their depositors."
Protecting their customers
And it is the ongoing relationship that makes a difference, according to Richele Messick, a Wells Fargo spokeswoman. "We are here to help our customer to succeed financially," she said. "It isn't good for Wells Fargo if this service doesn't meet its intended purpose, which is to help customers through an emergency situation."
Wells Fargo has offered its "Direct Deposit Advance" for 18 years. It limits the loans to half of a customer's direct deposit or $500, whichever is less. It charges $7.50 per $100 borrowed — less than other banks. It needs to be paid in full before another similar advance cab be taken out. And, if for some reason the customer's direct deposit suddenly goes down, Wells Fargo will not touch $100 of the deposit — leaving a buffer and avoiding an overdraft. The bank waits for the next deposit before continuing taking out more of the payment.
But even with Wells Fargo's protections in place, a person could theoretically take six consecutive $500 advances and then four more months of lower advance amounts.
Martin at the University of New Mexico said, "I think a lot of banks do not want to make these sorts of loans — that they find it somewhat reprehensible to make loans at 250 percent interest and higher, I hope this won't become a trend."
But Messick wants Wells Fargo's clients to make their own assessment as they have for years. "We try and show our customers what other options there might be and what the fees are for those credit options," she said. "We definitely want our customers to make informed decisions about their financial choices."
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