Do the Right Thing- Helping Consumers Avoid Pay Day Loans

Many of us have been up late at night watching television have heard the commercials.  Or perhaps you have heard them while listening to the radio.  The announcer comes on and asks whether or not you have some emergency cash needs,  Well, assures the friendly announcer here at EZ loans, we are here to help.  All you need is a checking account and a paystub and we can loan you cash that will be put into your account tomorrow.  The appeal you are listening to is the siren call of the Pay Day lenders.  These lender position themselves as helping customers by doing for them what the banks won’t;  making them a loan in their time of need.  The truth is that nothing could be further from the truth.  These loans more often than not put the borrowers on a never ending spiral of increasing debt and financial ruin.   Recent comments by the Comptroller of the currency indicates that favorable consideration will be given to the bank that embraces the needs of the payday lender customers. 

Why get a Pay Day Loan? 

Payday loans are short term small dollars loans that almost always have a balloon repayment feature.   In fact, these loans are called “payday loans” , because they are generally due at the time of the borrowers payday.  Consumers take these loans out because they have immediate need of small amount of funds, to do things like pay a doctor bill, get a car repaired, etc.  There are many different reasons that have been noted for getting a payday loan.  These loans tend to be very small in size  averaging about $250 and they tend  to last 14 days  or until the next pay period.[1]   

One of the surprising features of the these loans is the fee structure.  The CFPB recently did a survey of these loans and found the following: 

The cost of a payday loan is a fee which is typically based on the amount advanced, and does not vary with the duration of the loan. The cost is usually expressed as a dollar fee per $100  borrowed. Fees at storefront payday lenders generally range from $10 to $20 per $100, though loans with higher fees are possible….. A fee of $15 per $100 is quite common for a storefront payday loan, and would yield an APR of 391% on a typical 14-day loan.  [2]

 Another troublesome feature of payday loans are that since the entire loan balance is due and payable when the borrower gets paid , the borrower often does not have enough money to pay the loan and all of the regular monthly bills.  The borrower then asks for a renewal of the loan and so the cycle begins.   The CFPB described it this way:

§  Over 80% of payday loans are rolled over or followed by another loan within 14 days (i.e., renewed). Same-day renewals are less frequent in states with mandated cooling-off periods, but 14-day renewal rates in states with cooling-off periods are nearly identical to states without these limitations.

§  Few borrowers amortize, or have reductions in principal amounts, between the first and last loan of a loan sequence[3]. For more than 80% of the loan sequences that last for more than one loan, the last loan is the same size as or larger than the first loan in the sequence. Loan size is more likely to go up in longer loan sequences, and principal increases are associated with higher default rates.

§  Monthly borrowers are disproportionately likely to stay in debt for 11 months or longer. Among new borrowers (i.e., those who did not have a payday loan at the beginning the year covered by the data) 22% of borrowers paid monthly averaged at least one loan per pay period. The majority of monthly borrowers are government benefits recipientsborrowers (48%) have one loan sequence during the year. Of borrowers who neither renewed nor defaulted during the year, 60% took out only one loan.

The CFPB study showed that the people who apply for and receive payday loans are in income ranges from < $10k annually up to $60k.  These figures only take into account the income stated on the loans received, so income ranges could be even higher.  The point is that, as the pay day lenders say in their commercials “we a’’ need money sometime”.    The fact is that past studies by the FDIC have some that less than 30 percent of low-income households and less than half of moderate-income households have at least $500 in emergency savings. 

And while this number may be somewhat troubling it also presents a strong case that there is indeed a market for some dollar loans for consumers. 

Time for Change

In his speech before the  before the  2014 National Interagency Community Reinvestment Conference in Chicago, Illinois , Thomas Curry, the comptroller of the Currency addressed this issue directly.  He noted the dismal history of this type of lending.  Mr.  Curry also pointed at that there had been similar products at some banks that were called deposit advances.  Guidance by the FDIC and the OCC has effectively ended this practice.   

We agree with My. Curry that there is a market for  small dollar loans. We are also intrigued by the suggestion that developing a program designed to assist these consumers will inure positive credit towards an institutions CRA lending test and possibly the service test.   

The potential exists then for a bank to  buttress its reputation in the assessment area, while making a modest profit and gaining positive CRA credit. 

Developing a Program

It goes without saying that one of the goals for developing a loan program for small dollar loans has to be to keep costs to the bank minimal.  Developing a set of data that can be easily collected and can be predictive about loan performance is most certainly not rocket science.   Using a formula to make these types of loans can reduce the costs of underwriting. 

One of the main features that must be avoided when making small dollar loans is a balloon payment.   This is the feature of pay day loans and deposit advances that the regulators found objectionable. 

We believe that what is imagined is a product that is designed to let a customer grow into a full-fledged profitable relationship.  A small dollar loan with reasonable terms allows the bank to report favorable information to credit reporting agencies.  It further allows the bank to reach to communities that have been traditionally under banked. 

Added a feature to the loan that allows the bank to give financial counseling to the customer gives the product the serve both the lending test and the service test requirements of the Community Reinvestment Act. 

If your institution is considering developing such a program, it is an excellent idea to get the input of your regulator.  By collaborating, you have the benefit of strengthening your relationship with your regulator, working through any troubles with the program and getting the “halo” effect of developing the program in the first place.  

By doing the right thing, your bank can gain several benefits. 

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[1] Some pay day loans for example, last 30 days to match the pay period of a borrower who is paid monthly. 

[2] CFPB, “Payday Loans and Deposit Advance Products, a White Paper of Initial Data Findings,” available at http://files.consumerfinance.gov/f/201304_cfpb_payday-dap-whitepaper.pdf  

[3] Loan sequence is defined as a series of loans taken out within 14 days of repayment of a prior loan.