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Payday Lending Under Increasing Scrutiny

Payday Lending Under Increasing Scrutiny
Posted: Jun 7, 2016
Categories: Rates, Regulations
Comments: 0
Author: Lou Grilli

Payday lending was once looked at by credit unions as both a threat and an opportunity. Multiple non-mainstream lenders, including Amscot, the Ez Money loan stores, and Cash America were attracting potential banking customers and credit unions members with brightly lit stores open 24 hours a day, with very few questions asked.

Payday loans are small loans generally in the $150-$400 range, repayable in a few weeks when the borrower is due to receive a paycheck or some other scheduled payment. The loan is designed to tide the borrower over until the payment is received. The cost of a loan is usually $15 to $20 for each $100 borrowed, regardless of whether repayment is due in one week, two weeks, or 4 weeks.

Banks and credit unions were looking across the regulatory fence at the profits being made by their unregulated competitors charging the equivalent of a 400% APR. And in 2011, the Washington Post stated that “an increasing number of credit unions are competing directly with traditional payday lenders, selling small, short-term loans at prices far higher than they are permitted to charge for any other product.” 2011 was the year that the National Credit Union Administration (the NCUA is the entity that regulates credit unions) allowed credit unions to charge up to 28 percent for loans under the condition that the borrower be allowed up to one month to pay, and no one borrower can get more than three of these loans in a six-month period, maximum loan amount of $1000, and a number of other restrictions. It was called the Payday Alternative Loan (PAL) program.

Roll forward to 2016 and payday lending is all over the news, but not in a good way. Lending Club, an internet-only crowd-sourced, non-regulated lender, faces a subpoena from the DOJ, an investigation by the SEC, a slew of litigation, and the mass exodus of almost all of its executive team. For reference, Lending Club passed $12 billion in loan originations. If it were a credit union it would rank among the top 15, but is currently spiraling downwards.

Google is doing everything they can to keep Payday loans from being advertised in search results. Google announced in May of 2016 that it is effectively banning terms used by payday lenders from AdWords. This ban by Google includes loans that have repayment dates that hit within 60 days of being issued. It also includes loans with an APR of 36 percent or higher in order to avoid promoting loans considered predatory.

CFPB clamps down

And in what could be the final straw the Consumer Financial Protection Bureau (CFPB) has announced on June 2 rules clamping down on short-term, high interest loans, which includes payday, auto title, and other high-cost installment loans. These new rules require lenders to impose a “full-payment” test which would ensure that borrowers have sufficient income to repay the loan and still meet other financial obligations such as basic living expenses; and limit repeated or roll-over loans.

So what changed between 2011, when the NCUA encouraged credit unions to get into the space, and today, when the CFPB is discouraging these type of loans? The loans were originally intended to help out short-term needs – a person who has a job but faces a one-time large car repair bill. Instead, a large demographic of unbanked, that in the past relied solely on cash, discovered the convenience of quick loans. This typical demographic is generally less educated, a group that needs the protection of regulation, but were being preyed upon by a large number of internet-only (low overhead, mostly un-traceable) lenders that capitalized on their lack of understanding of the hole they were digging for themselves.

The terms of these loans had a “balloon payment” due that typically consumes one-third or more of a customer’s next paycheck, according to Pew. Since this payment was so large, the borrower could not cover the amount due, and needed to immediately borrow again. Fees charged for these repayment loans were far in excess of what was advertised for the initial loan. Predatory lenders relied on borrower’s inability to dig their way out. For specifics, according to Pew, the average loan is $375, with $55 in fees, so $430 is due back in two weeks. On average, $430 represents 36% of the typical borrower’s paycheck. So when the loan comes due, the borrower needs ends up taking another payday loan. Before they can break the cycle, the borrower pays $520 on average in total fees.

The CFPB has proposed restrictions that will keep most borrowers from falling into these traps by extending the length of time a borrower has to pay back the loan, preventing lenders from excessive fees and limiting interest rates.

The future for the PAL program

And what about the PAL program from credit unions? There’s the potential that the CFPB payday loan regulations could shut down credit union alternatives. What is more likely is that for federally chartered credit unions, the PAL program would be exempt from the CFPB’s upcoming rulemaking. Regardless, there is still a market need that is not being addressed. The underbanked need access to low fee, low restriction banking products, including a basic debit card. But in many cases, scared off by big bank fees, they don’t know where to turn. Advertising in poorer socio-economic neighborhoods, advertising in social media (where these borrowers are finding the predatory online lenders in the first place) with a message that touts good banking habits, along with low cost, low fee products, would serve the community well. And credit unions are the perfect entity to take on this need.

After all, the heart of the credit union movement is built around a mission to serve people of modest means.

 

 


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Lou Grilli

Lou GrilliLou Grilli

Lou is the Director of Payments Strategy at CSCU and is responsible for providing leadership to the organization for emerging payments and industry trends, as well as managing the product portfolio.

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