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?