Payday loans are very, very expensive, and often trap consumers in a vicious cycle of debt that is hard to break. The sad part is that Americans at the bottom of the financial ladder, folks who barely get by paycheck to paycheck, have no option but to resort to these loans because banks and credit unions have not offered small short-term loans to consumers since the recession. Hence, a recent bulletin from the Office of the Comptroller of the Currency (OCC) was welcome news for cash-strapped consumers. The bulletin issued on May 23, 2018, “encourages banks to offer responsible short-term, small-dollar installment loans, typically two to 12 months in duration with equal amortizing payments, to help meet the credit needs of consumers.” The bulletin, essentially, gave banks the green light to return to the short-term lending market and reflects a relaxation of banking regulations.
U.S. consumers borrow about $90 billion each year in short-term, small-dollar loans, typically ranging from $300 to $5,000. The opportunity is huge, banks and credit unions should step-up to the challenge, give payday loans a run for their money . . . and perhaps have the following scene from Yes Man play out for some enterprising loan officer.
Payday Loans make low-income Americans poorer
- Payday loans have an average APR (annual percentage rate) of 390 percent
- Payday borrowers earn about $1,250 per bi-weekly paycheck ($30,000 per year), and three-in-five borrowers have trouble meeting routine monthly expenses
- Roughly 12 million Americans take out payday loans each year, paying about $9 billion in loan fees
- Payday loans average about $350 each, and typically mature in two weeks (tied to the borrower’s pay cycle)
Payday lenders have direct access to a borrower’s checking account so they can collect balloon payments (principal + interest) from the borrower’s payroll direct deposit before other lenders, or bills, are paid, further risking the borrower’s credit.
While payday loans are marketed as a source of short-term cash for life’s emergencies, desperate borrowers resort to them repeatedly to meet household budget shortfalls.
For example, the average payday loan requires a lump sum repayment of $430 on the next payday, which consumes about 34 percent of an average borrower’s $1,250 pre-tax paycheck. However, most borrowers can’t afford to pay any more than 5 percent of their paycheck while still covering basic expenses. As a result, most borrowers renew their loans and get locked into a cycle of ultra-high-interest debt that ruins their finances, their family life and their peace of mind.
Banks should rise to the challenge with humane short-term lending programs
Banks and credit unions should see the bulletin as a clear nudge from the OCC to:
- Do good by responsibly engaging in short-term consumer lending, and providing much needed financial relief to millions of low-income Americans who are currently held captive by payday loans
- Help consumers with their short-term financial needs, while establishing a path to more mainstream financial products, and gain significant customer loyalty and goodwill
- Break payday loans’ vicious cycle of debt and disproportionate costs by understanding the urgency of cash needs, expediting loan approvals, and implementing reasonable and humane loan workout strategies
- Boost branch profits by expanding into an under served $90 billion niche
Analysts believe that limiting installment payments to no more than 5 percent of monthly income would break the vicious cycle of debt that balloon payments create. More than half of all the banks and credit unions support the 5 percent payment cap, making loans more attractive with affordable repayment terms while following banking best-practices on credit analysis and loan underwriting, treating customers fairly, and complying with the law.
