Federal agencies are preparing to rein in small-dollar payday loans at banks and storefronts, drawing cheers from consumer advocates -- but increasing concerns that the rule-makers are already a step behind sketchy online lenders.
The action on payday loans is coming from two fronts. First, federal bank regulators at the Office of the Comptroller of the Currency and at the Federal Deposit Insurance Corp. issued proposed new rules on Thursday about offering payday-like "deposit advance" loans. The rules focus on borrowers' ability to repay the loans, and set firm limits on how frequently they can dip into credit.
Second, the Consumer Financial Protection Bureau issued a damning report on payday and deposit advance loans on Wednesday, and all but promised that rules are on the way to protect consumers from a costly treadmill of recurring debt.
"For too many consumers, payday and deposit advance loans are debt traps that cause them to be living their lives off money borrowed at huge interest rates," CFPB director Richard Cordray said in an announcement of the study.
Day of reckoning
More and more hard-pressed households have opted for payday loans since credit card issuers began shedding less creditworthy borrowers following the recession and the Credit CARD Act . According to payday loan industry group Community Financial Services Association of America (CFSA), more than 19 million households a year take out a payday loan. The loans usually provide a few hundred dollars for a couple of weeks until your next check comes in. The lender gets your permission to tap your checking account to repay the loan.
"We're glad the CFPB is focusing on payday loans, which we think are an abusive product," said Lauren Saunders, managing attorney for the National Consumer Law Center in Washington, D.C.
According to the Conference of State Bank Supervisors, 29 states already supervise payday lenders, providing a laboratory for dealing with the industry's pitfalls. Some states set interest rate caps -- a power beyond the federal consumer bureau's reach. Other ideas include a cooling-off period between loans to keep them from becoming a habit.
"They (CFPB) have different tools in their toolbox than the states do," said Margaret Liu, senior vice president of the conference's legislative division.
The CFPB's report acknowledged that true short-term emergency loans can be a boon for consumers. Then it went on to show that the reality of payday lending is very different for most people. Forty-eight percent of borrowers in the one-year study took out loans more than 10 times, generating 75 percent of the fees that lenders collected. The typical user took out 10 payday loans during the year, the report said, and paid $458 in fees.
The conclusion supported previous findings by consumer advocates that the payday lending business is based on a recurring debt burden that drains money from working families. Typical fees, which amount to an APR of 391 percent, leave many people tapped out, needing another loan to meet living expenses.
The CFSA sets industry rules for its members, including limits on repeat loans, said Amy Cantu, the group's director of communications and research. Loan rollovers are limited to four, and people who need more time to repay are supposed to be offered an exended payment plan. The organization represents about 9,000 storefront lender locations, an estimated 60 percent of the U.S. market. That leaves thousands more establishments operating outside the guidelines.
Online lenders spared -- for now
Any CFPB action will likely try to address that gap. But it's holding off on decisions about another large segment of the market: Internet payday lenders. The industry is increasingly moving online, the CFPB paper said. The agency is conducting a separate look into online payday lending.
"In the absence of payday loans, people are forced to turn to illegal offshore loans, which are inherently more dangerous products at higher costs," said CFSA's Cantu.
Online activity can be more difficult to oversee and regulate, potentially providing a new hurdle for combating abusive practices. "It can be difficult, but not impossible, for states to assert their jurisdiction," Liu of the state bank supervisors said.
Deposit advances under scrutiny
Deposit advances , which work in ways similar to payday loans, are offered by a few banks, including Regions and Wells Fargo. The accountholder takes an advance to pay bills, and the bank is repaid from funds in the next deposit.
As with payday loans, the CFPB found that heavy users made up the largest share of the business. Only 14 percent of deposit advance borrowers took out more than $9,000 in advances, but that small segment accounted for 42 percent of the business by dollar volume. Over the course of a year, this group typically spent 254 days -- about 70 percent of the time -- with an outstanding loan balance costing them interest.
The banking industry points out it's not pushing these products on an unwilling public. "These (deposit advances) are not something that is promoted -- people have to go out and find it," said Nessa Feddis, vice president and senior counsel at the American Bankers Association. "How they choose to use it is their business."
Feddis said the industry group is pleased that the CFPB paper calls for a discussion of its conclusions -- but the conversation may not be necessary. The expected guidance from bank regulators at the OCC and FDIC could lead banks to conclude that it is not worth their while to offer deposit advances. "It may be intended to kill the products," she said.
The FDIC and OCC rules say advances should be repaid before a new loan is extended, with a firm one-month "cooling off" period between loans. Otherwise, borrowers who are unable to pay their bills and fully repay the loan are forced to take out another loan, incurring another fee. Current bank rules for cooling-off periods can be easily avoided, the agencies said.
In addition, banks must evaluate the borrower’s ability to repay the loan and still meet their basic expenses. It is not enough that a borrower's regular deposit is enough to cover the loan amount. Some lenders tack on overdraft fees if there is not enough money in the borrower's account to repay the loan on the due date, the regulators said.
Ending dependency on repeat loans is easier said than done, Feddis said. Banks that do offer deposit advances usually have limits on usage and provide ways for users to gradually scale back their borrowing. "To just cut (credit) off cold can really disrupt people's lives," she said.