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Susan Tompor: Payday loans rule could lead to cheaper alternatives

Susan Tompor, Detroit Free Press on

Published in Home and Consumer News

Consumers who are caught in a financial squeeze might one day be able to skip the payday loan store and turn to banks and credit unions for lower-cost, quick-fix loans.

That's one possibility being raised by consumer advocates who want to see an end to gruesome, triple-digit rates that are charged to vulnerable consumers who take out payday loans.

The Consumer Financial Protection Bureau's final payday loan rule -- which was announced Oct. 5 and could go into place in 2019 -- could open the door to lower-cost installment loans from banks and credit unions, according to Nick Bourke, director of the Pew Charitable Trust's consumer finance project.

Before that happens, Bourke said banks would need to receive clear guidelines from regulators. But the loans could be six to eight times less costly than payday loans.

We're in a wait-and-see mode. Congress could move to overturn the rule -- but some say that's unlikely.

What could change: Lenders eventually would be required to research upfront whether borrowers could afford to repay all or most of their short-term loans at once -- including payday loans and auto title loans -- and longer-term loans with "balloon" payments.

Under the rule, a lender would have to verify income and major financial obligations and estimate basic living expenses for a one-month period -- the month when the highest payment is due.

Banks and credit unions have some advantages because they already have customer relationships and can automate loan origination. Pew has advocated for streamlined underwriting guidelines on bank-issued installment loans that allow monthly installment payments of up to 5 percent of monthly income.

What won't change: People who are cash-strapped still will be looking for ways to cover their bills.

"They're in desperate need of help," said Herman Starks, bishop of Christ TRUTH International Ministries of Deliverance in Detroit.

Starks said he knows of one woman who lost her job and didn't have a regular paycheck. But somehow, she got a payday loan to cover some of her bills. Many lenders do treat Social Security and disability payments as sources of income.

The Detroit woman had hoped she'd have another job by the time the payday loan was due but that didn't happen.

"She never got caught up," Starks said.

Payday loans offer a quick fix but consumer advocates warn that the loans can lead to long-term debt traps.

Many times, people think it's easy to take out a loan of $250 or $300 and pay it back by the next paycheck, usually in two weeks or four weeks.

Too often, though, payments on the loans, including interest and fees, bite into one third of the typical borrower's next paycheck, according to Pew's research. The borrower isn't able to cover basic expenses without taking out another payday loan.

Bourke noted that Pew's research indicates that a debt spiral can be triggered if a payday loan payment exceeds 5 percent of one's paycheck.

Many payday borrowers typically make $2,500 a month on average before taxes, so they might be able to afford a $125 payment. If they took out a $500 loan, they'd typically need to repay that loan with interest over five or six months, he said.

Trying to repay that loan too quickly -- or extending it for more than a year -- creates financial struggles.

Because the loan is short-term, the annual percentage rate can end up being 300 percent or 400 percent.

Too often, people aren't calculating how quickly interest or fees can build up.

"The cycle of taking on new debt to pay back old debt can turn a single, unaffordable loan into a long-term debt trap," Richard Cordray, director of the Consumer Financial Protection Bureau, said in a statement.

Some people don't have other means -- such as a credit card -- to dig out of a financial jam. They might have low credit scores and not qualify for a typical credit card.

So consumer advocates want to see other types of lower-cost loans that pose less risk to consumers than payday loans.

Risk can go down if repayment can be spread over a longer time frame.

Small-dollar loans that last more than 45 days, for example, might replace some payday lending because they're not covered by the new rule that requires lenders to determine a borrower's ability to repay, Bourke noted.

But Bourke said there are a lot of harmful installment loans on the market today and it's possible that some payday lenders would expand into longer-term installment loans to offer a product that's not covered under the CFPB's rule.

As a result, he said, individual states may want to further regulate such loans.

Because the payday lending rules don't hit immediately, Bourke expects that some new types of loans might be tested. Consumers will want to look out for hidden fees or other traps.

The new rule exempts what are called "payday alternative loans" authorized by the National Credit Union Administration.

Payday alternative loans cannot be rolled over into another loan. Loan amounts run between $200 and $1,000. The borrower must be a member of the credit union for at least one month. And the term of the loan can range from one month to six months.

How many new products we'll see, though, is unknown now.

The new rule for short-term, small-dollar credit is spelled out in more than 1,600 pages, so banks say it will take time to review what options exist. The Community Bankers Association has complained that the CFPB should have worked with other banking regulatory agencies to examine the use of small-dollar lending programs, such as deposit advance products, so consumers could receive short-term emergency loans from their banks.

Deposit advances are short-term loans that are similar to payday loans but typically banks and credit unions offer them only for their own customers.

Payday lenders aren't thrilled by these changes -- and we can expect pushback.

Before consumers take out payday loans, though, they can ask themselves whether they have a realistic chance for being able to quickly repay a high-cost loan. It's good to explore other options -- including asking family members for help or even pawning some goods -- long before any new payday lending rules might take place.

About The Writer

Susan Tompor is the personal finance columnist for the Detroit Free Press. She can be reached at stompor@freepress.com.

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