Federal regulators scrutinize banks' 'advance direct deposit' loans
Short-term loans from both banks, payday lenders drawing fire
By James Peter Rubin
Need cash in a hurry?
People who have run to the neighborhood cash advance outlet
for quick money are finding more sources for short-term loans in unexpected
places -- local bank branches.
At least five regional and national banks now offer versions
of "advance direct deposit" loans. Banks advance borrowers the money, with the loans repaid from scheduled future direct deposits -- usually from paychecks or Social
Security and other government benefits.
Consumer groups say the loans closely mimic the terms of
controversial high-interest payday loans
nonbank, retail outlets in urban and rural areas across the country.
"Advance deposit loans are billed as short-term, but
snare consumers in long-term debt," says Kathleen Day, a spokeswoman for
the Center for Responsible Lending, a North Carolina consumer advocacy and
research organization. "What do you
think the chances are that a person who takes a loan that's big interest and
short term can pay back the loan and fee and still have enough for goods and
services? Not high," Day says.
In February 2012, the group was one of 250 national and
regional consumer, religious and community groups and individuals asking
federal regulators "to take immediate action to stop banks from making
unaffordable, high-cost payday loans."
Rising demand from some banking customers for small-dollar,
short-term loans has led U.S. Bank, Regions, Guaranty and Fifth Third banks to
offer "advance deposit" loans ranging from $1 to $1,000. A fifth
bank, Wells Fargo, has been offering short-term loans since 1994.
The new federal financial watchdog agency, the Consumer Financial Protection Bureau (CFPB), has launched closer scrutiny of both banks
and payday lenders offering high-interest, small-dollar loans with an eye on whether these loans are fairly marketed to low-income consumers.
How the loans work
Here's how advance deposit loans work:
Say you need $100 to pay your rent or cover some other
expense, but don't have the money in the bank. You've been receiving $500
monthly via electronic deposit. The bank agrees to a loan on the assumption
that it will be able to automatically draw the full amount plus a fee from your
next $500 deposit. There's no check of the borrower's credit history. The loans are popular
partly because consumers can gain access to money quickly. The fee usually
ranges from $7.50 to $10 per $100 borrowed. Guaranty Bank charges a flat $30
each time a customer applies for the loan. Repayment is required within 35
days. (See chart.)
Advance deposit loans are billed as short-term, but
snare consumers in long-term debt.
|-- Kathleen Day
Center for Responsible Lending
Consumer groups say that people who use these loans are
usually the most needy but least able to repay them on time. The bank repays
itself regardless of whether borrowers have sufficient deposits in their bank
accounts. This can create an overdraft in the account.
Opponents of the loans say that while the fees appear appealingly low, when calculated as interest and compounded annually, the loans are actually much higher than other
loan and credit products. The APR equivalent on an
advance direct deposit loan may range from 120 percent for a 35-day repayment term to
more than 400 percent if the period is two weeks or less. Credit cards typically charge 10 percent to 25 percent, depending on creditworthiness. Home equity loans are
Nessa Feddis, vice president and counsel of the American
Bankers Association trade group, said in a statement to the Office of the
Comptroller of the Currency that its "inappropriate" to measure the
cost of advance loans by APR because "they are not annual loans."
Banks: Loans aren't
Banking industry representatives defend their products as legitimate
services addressing a common need -- quick cash -- for a segment of their customer base. They also say the loans are closely
monitored to ensure that consumers do not use them unwisely. In addition, all of the
banks give warnings to potential customers in their product guides and
literature that the loans are expensive and not designed as long-term
U.S. Bank, for example, has this warning in bold type: "Checking Account Advance is designed for unexpected short-term credit needs and is an expensive form of credit. If you decide to borrow, borrow only as much as you can afford to repay from your next deposit."
Richele Messick, a spokeswoman for Wells Fargo, said, "The service was designed to get customers through
emergency situations, not to solve their long-term credit needs."
She added: "We want to help them
through all their different financial needs. We believe that this is an
important service to offer because of the need for short-term, low-sum credit
Spiral of debt?
A 2011 report by the Responsible Lending group on "Big Bank Payday Loans" found
that 44 percent of customers' next deposits go to repay their loans.
Advance direct deposit loan customers are in debt for an average of 175 days,
nearly twice as long as the 90-day maximum recommended by the Federal Deposit Insurance Corp. for high-cost debt. "This large proportion no doubt
contributes to the long-term debt cycle experienced by many payday
borrowers," the report says.
Payday loans charge as much as $17.50 per $100 loan with
repayment often due in 10-14 days and the equivalent of APRs in the middle to
high triple digits. Seventeen states, including Arizona, New York, New Jersey
and Ohio, plus the District of Columbia, have limited interest rates to 36
percent, and passed other restrictions on short-term loans. A federal law
placed a similar cap on loans to service members.
"Banks say advance deposit loans are not a payday
loan," says Day from the lending advocacy group, "But everything acts
like a payday loan. It's exactly the same thing."
"It's a debt trap," says Kelly Griffith,
co-director of the Southwest Center for Economic Integrity, a Tucson, Ariz.-based
research, education and consumer advocacy group. "If you can't make money
with a 36 percent gap, then you shouldn't be making that kind of loan."
Closer federal oversight
Richard Cordray, the director of the federal CFPB, which oversees financial
products, said in January 2012 his agency would be "paying close
attention to deposit advance products at the banks that offer them."
The service was designed to get customers through
emergency situations, not to solve their long-term credit needs.
Wells Fargo bank spokeswoman
He spoke at a special hearing on payday lending held in Birmingham. The CFPB issued a field guide -- "Short-Term,
Small-Dollar Lending Procedures" -- for the agency's examiners as they
look at how banks and payday lenders "conduct business." Cordray said
the examination would include "looking at the materials and strategies
that are used to market the loans."
Representatives for Wells Fargo, Fifth Third and Regions
banks say that they're offering a valuable service for consumers. All five
banks currently offering advance direct deposit loans outline in their online
marketing materials that consumers should think carefully before choosing this
Wells Fargo had safeguards in place that required balances
to be paid off before consumers could borrow again, says Messick. Wells and other
banks also include "cooling-off periods" for individuals who have
borrowed money on these types of loans for six consecutive months.
Regions Bank spokeswoman Evelyn Mitchell said that her
company offered its Ready Advance product in response to customers, many of
whom were already using a nonbank, advance loan product. She said that Ready
Advance was designed to meet the occasional and immediate credit needs of
existing Regions Bank customers who have had a checking account in good
standing for at least nine months.
Better than payday loans?
Compared to payday loans, the bank-sponsored advance loans may be better
alternatives, says Brian Melzer, a finance professor at Northwestern
University's Kellogg School of Management. Melzer has researched the negative
effects of payday loans. He found that households with "better access to
payday loans are more likely to report financial distress."
Melzer says the advance deposit loans may be a better choice
for those families because the fees are lower than payday loans, and banks have
the resources to monitor the loans more closely.
Still, he "puts the advance deposit loans in the same
category as payday loans." Melzer says that the most effective way to handle
small financial emergencies is by avoiding them through more careful money management.
"You have to budget better and accumulate a buffer of
savings so that when you get expenses, you have enough to cover them,"
Melzer says. "Then you'll be able to make it through."
|Comparing advance direct deposit loans
Big banks are offering small-dollar, high-interest loans that have traditionally been the realm of payday lenders and consumer groups are not happy about the development. The banks warn consumers that these loans are not for everyone and cheaper forms of credit are available.
Fifth Third Bank
$1 for every $10 borrowed
Up to 35 days to repay
Checking account holder in good standing at least 90 days and receiving at least $100 in direct deposits
$200-$400, or up to half of average direct deposits from previous 2 months, whichever is less
$30 application fee per loan, regardless of whether application is approved
Up to 35 days to repay; afterward remaining balance deducted from checking account, which may trigger overdraft fees
Existing direct deposit customers in good standing for 30 days or customers with checking accounts open at least 120 days
$50-$500, or up to half of direct deposits.
$1 for every $10 borrowed
Up to 35 days to repay; installment plan available for 21% APR
Checking account holder at least 9 months; at least $500 in total direct deposits
Checking Account Advance
$20-$500, or up to half of direct deposits of $100 or more
$2 for every $20 borrowed
Up to 35 days to repay
|Checking account customer at least 6 months receiving at least $100 electronic deposit
Wells Fargo Bank
Direct Deposit Advance
$500, or up to half of qualified direct deposits to the nearest $100
$1.50 for every $20 borrowed
Up to 35 days to repay; installment and mail-in options available
Deposit account holders with at least one recurring direct deposit of $100 or more every 35 days
Terms are subject to change by banks. Chart is current as of April 25, 2012.
See related: Big banks get into the payday loan business
Published: April 30, 2012