Short-term loans are marketed under all kinds of labels: payday, bill-pay and deposit-advance loans. But no matter the name, the premise is always the same: consumers in need of a quick cash fix agree to swap next week’s deposit — whether in the form of a payroll check or some other recurring source of income — for a stack of dead presidents today.
It would be one thing if these loans were reasonably priced, but that’s not the case. What sounds like a modest charge — 10% of the borrowed amount, say, plus a little interest — is anything but that when the charges are mathematically combined into an annual percentage rate equaling several hundred percent.
Profit motivations notwithstanding, the APRs are high because, as the money is outstanding only for a week or two, the costs that are associated with their set-up and servicing must also be recovered within that abbreviated period. What’s more, this method of financing can create a cash-flow hole that’s difficult to fill for consumers who are already experiencing liquidity problems. Consequently, the loans are often re-borrowed over and over again.
So it’s not surprising that many consumer advocacy groups, state attorneys general and the federal government are all targeting these products and the lenders that offer them. The challenge, however, is to come up with a way to rein in potentially predatory transactions that are marketed to consumers with limited means by disparate lenders who are subject to differing levels of oversight and legal limitations.
The results have been disappointing.
A Look at the New Rules
Take for example the recently finalized guidance that the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. put forth to address deposit-advance loans. It calls for enhanced credit underwriting and, even, a cooling-off period in between loans (which will undoubtedly harm borrowers more than lenders, given the structure of these financings).
Here’s the rub, though.
These rules pertain to the large, national banks that the OCC and FDIC oversee and not to those that are regulated by other federal and state agencies, nor to the nonbanks that are subject to the laws of the jurisdictions in which they operate.
There is a simpler way to go about this.
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Instead: Be Inclusive
All lenders — banks and nonbanks alike — that are engaged in short-term lending of this type should be governed by a single set of regulations that, among other things, limits APRs to a rational level and extends the repayment terms.
These loans are, in a sense, collateralized by a predictable flow of deposits (a bi-weekly payroll, for example) that lenders are able to verify and secure by way of preauthorized checking account debits that coincide with the anticipated deposit dates. The enhanced credit underwriting that the OCC and FDIC are mandating will also help them to gain a fuller sense for a prospective borrower’s financial circumstances. Together, these two actions make it possible to significantly diminish the lender’s risk of loss, which should also reduce the borrower’s cost.
As for the repayment term, lengthening it would give lenders the ability to amortize their expenses at a more moderate pace, which will favorably affect the APRs for borrowers. More important, borrowers would also be in a better position to fill in the cash-flow holes they’ve dug because the loans would be paid over time, rather than in one lump sum.
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Given the precarious financial condition of so many households — three-quarters of all U.S. adults are living paycheck to paycheck and half have fewer than three months of emergency savings on hand — there is a legitimate need for products of this type. Unfortunately, though, it seems as if many of the companies that offer them have made the decision to charge as much as they can for as long as they can get away with it.
Here’s the question shareholders may want to ask management teams who are stubbornly clinging to practices that are lightning rods for regulatory actions, legal challenges and the resultant reputational harm: Can you honestly say that after all the legal and public relations bills are paid, the company is in as good or better shape than if it had priced and structured these products more reasonably in the first place?
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.