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Payday Loans

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?

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While the mainstream financial industry has faced a dizzying array of government and quasi-government regulations through most of the last one hundred years, non-bank financial products have, for the most part, evaded regulations. Catering to lower-income communities, payday loan storefronts and check cashing establishments have managed to justify their business models. The more desperate you are to pay your electricity bills and your rent before your power is turned off and you’re evicted, the more likely you are to willfully ignore the fact that the companies helping you are taking advantage of you in ways that a traditional bank would never be allowed to do.

The Consumer Financial Protection Bureau (CFPB) is now charged with recommending new regulations that go beyond retail banks, thrifts, investment banks, and credit unions into the murky world of non-bank financial products.

If you compare a short-term payday loan with a loan from a bank, you might see that the payday loan’s equivalent interest rate (APR) is 450% or even higher. Mortgages tend to be 3% to 7%, business and personal loans could be 5% to 10%, and credit cards are 10% to 20% unless you default. Anything higher, and the loan might be considered usurious. So how do payday lenders get away with charging 450% or more?

Well, these lenders frame what they charge as a flat or sliding fee, not interest. The loans are typically due in two weeks, the expected arrival of your next paycheck. It might not be fair to compare these fees with interest rates, because the borrower doesn’t hold onto the loan for a long time.

Or does he? There’s some evidence suggesting payday loans create a cycle; rather than paying off the loan when the next paycheck arrives, lenders offer an enticing deal to encourage borrowers to begin the next loan. The two-week cycle repeats.

The CFPB wants to hear from people who have had experiences with payday lenders. In order to get a good grasp on how non-bank financial products can and should be regulated, the organization is seeking comments from the public. What have been your experiences with payday loans? Feel free to share here on Consumerism Commentary, or tell the CFPB your story directly.

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Consumerism Commentary reader Yana wrote in yesterday to let me know about some changes in the terms for Wells Fargo’s Direct Deposit Advance service. At first, I was surprised that this service exists. At its core, the credit product offered by Wells Fargo is basically a payday loan, though it comes from a reputable financial institution rather than a shady operation — or shadier, depending on your opinion of financial institutions.

My surprise faded quickly. Wells Fargo’s service is fairly low-risk from the bank’s perspective, particularly when compared with typical payday loans. Companies that pay salaries through direct deposits from companies are generally more reliable than customers who need to show up with their next paycheck. Those who use this service are already customers of the bank and have gone through any necessary background checks. Yet, the bank can still charge over-sized fees, just like payday loan companies. In Wells Fargo’s case, the fee is $2 for every $20 borrowed.

Even within Wells Fargo’s own list of frequently asked questions about the Direct Deposit Advance service, the bank warns customers that the product isn’t right for all customers:

It is important to note the Direct Deposit Advance service is a relatively expensive line of credit intended to assist with short-term borrowing needs and is not recommended as a solution for your long-term financial needs. Alternative forms of credit may be less expensive and more suitable to your long-term financial needs.

If the bank is steering you away from its own product, it’s best to stay away. Tellers might recommend this product to customers who come to the window without any warnings about price, however, and customers who are worried about being able to pay their bills might not be looking online for more information about the product before signing up.

The terms of the Direct Deposit Advance service have changed to further keep customers off the program. Habitual borrowers will find that their credit limit will gradually decrease if they continue to use the service, to the point at which borrowing against a future deposit will be prohibited for a period of time.

Gradually reducing a credit line could be an effective way to move people off of credit, but it could make living difficult for any household that has grown accustomed to having the credit available. A better solution might be counseling with a qualified individual who can help look at the household expenses and develop a plan for rising above paycheck-to-paycheck living.

What do you think of Well Fargo’s plan to gradually ween habitual users of the Direct Deposit Service off this expensive credit product?


I consider payday loans one of the worst forms of debt. That being said, in states where these services are still legal, they provide a way for struggling individuals to afford necessities like food and housing until their next paycheck, for a fee. Unfortunately, many borrowers don’t simply use their paycheck to pay back the loan and move on when it is due. One loan is often rolled into the next, for another fee.

A typical fee for a payday loan is $17 per $100 borrowed. That fee is due when the loan is repaid, usually within one or two weeks. While this cost of the loan could be considered a 17% fee, an annual rate is used to compare payday loans with other loans. The annual interest rate for a consumer loan from a bank may be 10%, but the payday loan works out to an annual rate of almost 450%, assuming the loan carries a term of two weeks.

The operative phrase is “a term of two weeks.” How is it rational to compare these two products using an annual interest rate? Only if the loan is extended and renewed repeatedly does it become a significant financial burden worthy of the interest rate stigma of 450%.

I am not defending payday loan companies. These lenders prey on individuals and families in desperate financial situations, often with nowhere else to turn. There is a strong possibility of borrowers falling into a spiral of increasing debt with back-breaking fees, and this is why these products are becoming illegal in more states. Arizona is the latest state, banning predatory loans with interest rates higher than 36%.

I do, however, believe the numbers used in the argument against payday loans are often illusory. Should loans due within two weeks annualize their fees into interest rates to face comparison with long-term loans?


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