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Should the Government Ban Banks’ Payday Loans?

This article was written by in Banking, Debt Reduction. 14 comments.


When we think of predatory lending practices, the first thought that often comes to mind is the payday loan industry, catering to people barely, if at all, living paycheck to paycheck. Payday loans service communities with an aversion or without a need for or trust of the mainstream financial industry. Offering short-term loans designed to help people survive until the next paycheck arrives, payday lenders charge fees, $16 per $100 borrowed on average, that would be considered usurious if measured by annual percentage rate standards.

Eager not to let non-banking lenders take all the best opportunities for profiting off families struggling the most, mainstream banks are in the payday loan business as well. They don’t call them “payday loans,” though. The name has a negative connotation. Instead, they use names like Wells Fargo’s Direct Deposit Advance, and tout their lower fees. The average fee for a mainstream payday loan is $10 per $100 borrowed, and the average duration of the loan is 10 days; the result is an annual percentage rate equivalent of 365%.

Despite the slightly lower fees, these products are likely more profitable for banks than payday loans are for independent lenders. With the bank-based products, borrowers are required to have direct deposit service enabled on their checking accounts. When the loan is due, the bank takes the money, including fees, out of the account without a separate authorization from the customer.

According to a recent study, borrowers tend to find themselves trapped in a payday loan cycle, continuing to borrow money to aid cash flow until yet another paycheck arrives after using the prior paycheck to pay off the previous loan. Banking customers end up owing money to the bank for an average of 175 days each year, slightly better than the average days in debt for a customer of an independent payday loan service, who owes money for an average of 212 days in the year.

One important distinction between payday loans and the equivalent products offered by banks is that the banks can report your credit profile to the reporting bureaus, Equifax, Experian, and TransUnion. There is no outcome where this is a significant advantage for the customer, though. Even if the borrower pays back the loan in full and on time, having this type of loan on your credit report could lower your score. A pattern of payday loans, paid back, can look worse on your report. The situation can only get worse from there, with patterns of late payment or non-payment drastically reducing creditworthiness.

According to the Consumer Financial Protection Bureau, which has made studying payday loans a priority, 19 million households in the United States use payday loans. That’s a huge, profitable market that banks want to tap, and customers seem to be willing to pay the price.

Have you ever borrowed money from your bank using a direct deposit advance loan or other payday-like loan product? Should these products be banned? Better regulated? I’ve often considered financial products to be like tools. For example, a credit card is like a hammer; it can be used to build when used properly or to destroy. Is the same true of payday loans and similar products?

Photo: bigburpsx3
CNN Money

Published or updated March 7, 2012. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 14 comments… read them below or add one }

avatar Ceecee ♦53 (Newbie)

The bank interest rate really seems high considering that they have a direct way to get the money back. The other companies—–I have mixed feelings. The rate is very high, but their risk is also much higher than the norm. Sometimes there’s a reason why your family or friends won’t spot you the cash—–they know your habits!!

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avatar krantcents

Why doesn’t usury laws prevent this sort of thing? Is it because there are fees vs. interest charged? I think it is just a way around the law. Hmmmm, a legal way to charge whatever you want!

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avatar jim

Because usury laws have been watered down to the point of not mattering. First the supreme court ruled that banks can charge the rate allowed in the state they are based from, so banks can locate their HQ in a state with high or non-existant usury limits. Then the federal govt. later exempted federally chartered banks from local usury laws. Combined these changes basically made local / state usury laws meaningless. You can find all the details on wikipedia.

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avatar Kevin Womack

I have a rather odd set of feelings on this. I will probably never take a payday loan or direct deposit loan. I’ve never needed a loan on anything other than real estate purchases, and hopefully never will. And I’m smart enough financially to know what a rip-off such practices are. But I still think they are necessary. If I had to choose between not eating between now and payday or getting a loan with a 365% interest rate, I would probably choose the loan. If the loan suddenly wasn’t an option, I may very well steal from someone or turn to another form of crime rather than go hungry. At least in jail I would get meals everyday.

That’s the real choice, allow institutions to take advantage of the poor or take away every option from the poor. So instead of regulating these places out of business, we should make it easy to loan money to the poor, so they have to compete for the business of low credit score individuals and hopefully the rates go down a little bit. They will never go down as the 2.5% home equity loans a person with a good credit score will get, but they might drop to something just high enough for the institution to make a profit when they account for a higher than average default rate.

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avatar qixx ♦1,890 (Half-Dollar)

Most people in that situation would get and use a credit card if at all possible. Even getting one at 30% interest rate beats the pants off any payday loan. Even Walmart has their own credit card and we all know the stereotype of the average Walmart shopper.

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avatar Squeezer

While most of us may not like payday loans for a variety of reasons, I still do not think the government should get involved in regulating a business. The payday lenders offer a service, the people are free to use it or not. Let the free market decide.

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avatar Tyler S.

These seems like the most logical approach. There are shady practices in all kinds of businesses. People still have to choose to go to these places and sign themselves up to pay these rates.

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avatar Tim Jones

I used to work for Fifth Third Bank and we offered a “payday loan” called Early Access. After 90 days of direct deposit history you became eligible. Your line of credit was based on your direct deposit history with the minimum being $100 and max $1000. There was a flat fee of 10%. Early Access advances were like cash and available right away for use. Example: $100 Early access advance cost $10 and $110 would be debited from your account from the next direct deposit. From my experience there were people who abused this product as a quick way to get money from day 1 and then got stuck in a rut and had there entire direct deposit go to pay off early access. However, the majority of people used it for what it was: an emergency line of credit. Don’t have enough in your account to cover a bill? No problem, use some Early Access. For example, I advanced $100 once (employees were eligible) to cover rent. The $10 early access fee was a lot less than my $70 late fee for my rental management account. Another example, overdrawing your account more than $5 incurred a $37 fee. If you overdrew your account to -$70 you could advance $70 early access and incur $7 fee instead of $37.

Your ability to advance money from your Early Access line of credit would be suspended if:
-You maxed your early access amount 5 times in a row
-were overdrawn for 15 days or more
-direct deposit stopped for 30 days

Early Access was a great tool to avoid fees in life. However like other financial products (credit cards) there is an inherent risk for abuse.

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avatar Investor Junkie

Have I used them? No. Should they be outlawed? No. I’ve covered this topic already. It will lead to this going underground instead. Paulie Walnuts will be coming to visit instead if you don’t pay.

http://investorjunkie.com/2624/payday-loans-vs-loan-sharks/

There is a legit need for them in the marketplace, but you can’t outlaw stupidity.

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avatar Azra, ReadyForZero

You bring up an interesting argument. It seems that the CFPB is looking to crackdown and regulate this type of Payday Loan lending in general so I’m looking forward to seeing what they’ll have in store for these lenders. What’s interesting is that Wells Fargo not only provides these loans, it also lends money to a number of prolific payday lending organizations such as Money Mart.

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avatar jim

Personally I think payday loans should be allowed, yet heavily regulated. I think they serve a purpose.

The payday loans look ridiculous if you turn it into an annual % rate. Yes charging $10 on a $100 loan for a 10 day period equates to >300% interest rate. That sounds awful. But what if you only charged 30% rate like a credit card? That would be a fee of $1. You really can’t expect a business to function if its lending $100 for $1. THey have to cover their overhead, fill out forms, etc. $1 probably won’t even pay for the paperwork. So some minimum fee amount like $10 makes more sense for a loan.

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avatar Evan

Just like with the CARD act – if Congress takes yet another stream of income away from the banks they will replace it with something else that may affect even more people (i.e. checking account fees)!

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avatar John

Isn’t that nice of Wells Fargo to disguise its payday loans under a friendlier name? I understand why they’re doing it (they want and need to make money), but hopefully they’re upfront with the ridiculously high fees. Consumers, be aware of the financial products you’re purchasing. You don’t want something that will destroy your financial health!

It was interesting to read that banks can report to the credit agencies whereas payday loan companies do not. Informative read!

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avatar shellye ♦107 (Cent)

Never borrowed any money from a payday loan company, but I work for a place that created an unsecured loan for those who want to repair, reestablish or rebuild their credit. The max loan amount is $500 and there is a $20 application fee with six months to repay. We encourage them to take several months to repay so there is a credit history to report. The interest rate is 18%, but it’s a fixed rate with a fixed payment. We do market it as an alternative to payday loans and have had some measured success since it’s implementation. The biggest challenge is to let people know it’s available.

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