When banks allow customers to borrow against upcoming deposits – of, say, Social Security checks or paychecks – the transactions are advertised as safety nets and protection against overdraft fees when emergencies arise.
In reality though, too many borrowers become trapped in a costly cycle of debt that can lead to more overdraft fees and other expenses, says a “white paper” issued this week by the U.S. Consumer Financial Protection Bureau.
“They continually re-borrow and incur significant expense to repeatedly carry this debt from pay period to pay period,” says the white paper. Whether the borrowing is done from a storefront payday loan company or a deposit advance at a big bank, “The high cost of the loan or advance may itself contribute to the chronic difficulty such consumers face in retiring the debt,” it said.
Now, federal regulators are poised to crackdown on the big banks, including U.S. Bank and Wells Fargo, offering loans tied to checking accounts, according to the New York Times.
“Regulators from the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation are expected to clamp down on the loans, which carry interest rates that can soar above 300 percent, by the end of the week,” the Times reported, attributing the information to “several people briefed on the matter.”
Banks urged to stop loans
In February, MinnPost reported in its Lending Trap series that several consumer advocacy groups in Minnesota had joined 250 organizations nationwide in a letter to federal regulators, urging them to stop banks from making such loans.
The Minnesota groups included Lutheran Social Service of Minnesota, Minnesota Community Action Partnership, St. Paul-based Jewish Community Action, several law firms and other organizations that work on behalf of immigrants, minorities and low-income families.
“At face value, the loans provide quick assistance to households who are struggling to make ends meet,” said Pam Johnson, who directs research for St. Paul-based Minnesota Community Action Partnership.
“But through our work and personal relationships with thousands of low-income Minnesotans, we know that household situation 30 days after the payday loan has not changed, and they will be unable to pay the loan on time,” Johnson told MinnPost in February. “This often results in an ongoing cycle of debt at extremely high interest rates that pushes families into desperate situations including foreclosure, bankruptcy and homelessness.”
In a nutshell, these loans allow regular bank customers to borrow, typically up to $600, on their next scheduled direct deposits. The bank automatically repays itself and also collects a fee once the deposit arrives in the account.
Now, regulators are expected to impose more stringent requirements on such loans, the Times reported.
“Before making a loan, for example, banks will have to assess a consumer’s ability to repay the money,” it said. “Banking authorities are also expected to institute a mandatory cooling-off period of 30 days between loans — a reform intended to halt what consumer advocates call a debt spiral of borrowers taking out fresh loans to cover their outstanding debt. As part of that, banks will not be able to extend a new loan until a borrower has paid off any previous ones.”
Another requirement will address marketing, the Times said.
“Because the advances are not typically described as loans, the interest rates are largely opaque to borrowers,” the newspaper said. “Wells Fargo, for example, charges $1.50 for every $20 borrowed. While the bank’s Web site warns that the products are “expensive,” there is no calculation of an interest rate. The banking regulators will require that banks disclose the interest rates, according to the people familiar with the guidance.”
In response to MinnPost’s questions in February, the banks defended their products. They insisted that their loans come with safeguards intended to avoid the pitfalls of storefront-style payday lending in which borrowers sometimes sink into unmanageable debt by seeking new loans to meet payments on old obligations.
“Checking Account Advance is a safety net for our customers who have experienced an unexpected expense such as a medical emergency or an auto repair,” Nicole Garrison-Sprenger, vice president for Corporate Public Relations at U.S. Bancorp, said in an email response to MinnPost’s questions.
Borrowers are warned each time they use the advance that it is high-cost credit intended to be used only for short-term needs, she said. They also are informed about alternative credit options that may be available. And the bank imposes mandatory “cooling off” periods as well as limits on the amount and duration of the advance.
“A small percent of our customers use CAA, but those who have give the product overwhelmingly high marks and appreciate having it available to them for emergency use,” she said.
In its white paper, the Consumer Financial Protection Bureau said that deposit advances and payday loans do, indeed, work as intended for some consumers for whom an unusual expense needs to be deferred for a short period of time.
However, it concluded that “a sizable share of payday loan and deposit advance users conduct transactions on a long-term basis, suggesting that they are unable to fully repay the loan and pay other expenses without taking out a new loan shortly thereafter.”
More than half of the deposit advance users in an in-depth study took out advances totaling more than $3,000, and they tended to be indebted for over 40 percent of the year, typically coming back for an additional advance within 12 days or less of paying off the previous debt.
“These products may become harmful for consumers when they are used to make up chronic cash-flow shortages,” the Bureau concluded.