High-cost installment loans: No improvement over payday loans

Until 2013, a handful of banks were siphoning millions of dollars annually from customer accounts through “direct deposit advance” — products that carried average annualized interest rates of up to 300%. Like storefront payday loans, deposit advance was marketed as an occasional bridge to a consumer’s next payday. But also like storefront payday loans, these bank products trapped borrowers in long-term, debilitating debt.

But banks lost interest in deposit advance thanks to 2013 regulatory guidance instructing financial institutions to assess borrowers’ ability to repay their loans based on income and expenses. Now, amid a tempest of deregulation in Washington, the banking industry is pushing regulators to let them back into the payday lending game. They should know better.

In a recent policy document, the American Bankers Association called on the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency to back off their 2013 guidance, the FDIC to withdraw different guidance dealing with overdraft protection and the Consumer Financial Protection Bureau to withdraw its proposed rule on small-dollar lending. “If finalized as proposed, the [CFPB] rule would curtail, if not eliminate, the ability of banks to make small dollar loans,” the ABA said.

Meanwhile, some banks also support a proposal championed by the Pew Charitable Trusts to provide certain exemptions from CFPB underwriting requirements for installment loans that cap monthly payments at 5% of income, contending that this is necessary to enable banks to serve small-dollar credit needs. But this plan won’t prevent consumer debt traps.

When researchers and consumer advocates call for restrictions on payday lending, they get two major lines of pushback. One is the claim that triple-digit interest rates are irrelevant because the loans are short term; the other is that small-dollar lenders are providing access to affordable credit in underserved communities.

But the fact that payday loans are actually designed and operate to trap borrowers in long-term debt negates those arguments. The CFPB has found that the median payday loan borrower gets caught in 10 loans per 12-month period. Our own research showed that bank payday lending was just as bad or worse. In 2012, we found that the median borrower of a payday loan product from a bank received 13.5 loans per year. Over half of borrowers had 10 loans per year. Over 36% had more than 20, and some had more than 30.

The typical payday loan borrower is unable to meet his or her most basic obligations and repay the payday loan debt in a two-week period. Within one pay period, families may have enough money to either repay their payday loan or meet basic expenses, but not both. So the lender, which has direct access to the borrower’s checking account as a condition of making the loan, flips the loan over until the next payday, which costs the borrower another high fee. The result is a string of high-cost, unaffordable debt. This is not a service to low-income communities; it’s a ticket to financial wreckage, increasing the risk of other late bills, closed bank accounts and bankruptcy.

While the banks are lobbying to get back into deposit advance products, another misguided push is underway that risks sanctioning banks’ ability to make high-cost installment loans. Despite support from Pew, which argues that high-cost installment loans can be structured to be affordable without examining both income and expenses in determining a borrower's ability to repay, this plan creates a loophole for banks to make unaffordable, high-interest loans again. These include the banks that formerly made deposit advance loans — some of which are among the largest banks pushing this plan — and those that didn’t.

The proposal is that the CFPB would exclude any loan in which monthly payments take up to 5% of the consumer’s total (pretax) income from a requirement that the lender determine the borrower’s ability to repay, which is the main requirement in the CFPB’s proposal. This proposal has also been floated to the Office of the Comptroller of the Currency, with the suggestion that the OCC exempt these loans from its underwriting standards as well.

But this loophole ignores a family’s expenses for a population that is typically already struggling to shoulder them. Consider a family of four at the federal poverty level of $24,300 annually, $2,025 monthly. A 5% payment-to-income standard would assume that the family has an extra $101 each month, or $1,215 annually, that they can spare toward service of installment loan debt. Even under the best circumstances, this often will not be the reality. Existing loan performance data on payday installment loans also show that these loans will often not be affordable. For these reasons, this proposed loophole is opposed by nearly every national consumer and civil rights organization.

With no interest rate limits and direct access to the borrower’s bank account for extracting payments (whether the borrower can afford their groceries or not), unaffordable payday installment loans trap borrowers in long-term debt with the same harmful consequences as traditional payday lending.

Low-income families in states that don’t allow payday lending report that they have myriad strategies for getting to their next payday when they are short on cash, including credit cards that are far cheaper than payday loans, payment plans with utility companies, and loans and credit counseling from nonprofits. The last thing they need, as former payday borrowers attest, is a high-cost debt trap that will make their situation worse.

Payday lenders will not stop making their false arguments. But the CFPB should finalize a strong rule that requires an ability-to-repay determination on all payday loans, high-cost installment loans and car title loans — regardless of who makes them. And the prudential regulators should not enable bank efforts to make unaffordable payday or installment loans.

The 15 states (and D.C.) that have banned payday lending, or never authorized it, have kept payday lenders out of their states only after pitched battles between a well-heeled industry and those fighting to protect working families, veterans, the elderly and low-income communities of color from 300% interest loans. If banks try to get back into this business, they will face the same determined opposition that helped drive them out in 2013.

And for good reason. Payday lending is harmful. Those bank CEOs who want to be decent to their customers should stay far away.