This article was reported and written by Kevin Burbach, Jeff Hargarten, Christopher Heskett and Sharon Schmickle. The article was produced in partnership with students at the University of Minnesota School of Journalism and Mass Communication, and is one in a series of occasional articles funded by a grant from the Northwest Area Foundation.
They’re not called payday loans.
Instead, big banks give these quick-cash deals more respectable-sounding names: “Checking Account Advance” at U.S. Bank, “Direct Deposit Advance” at Wells Fargo and “Easy Advance” at Guaranty Bank.
But those labels amount to a distinction with little meaningful difference, say consumer advocates, who point out that the annualized percentage rates of those advances can run well over 300 percent.
“These electronic payday loans have the same structure as street corner payday loans – and the same problems,” the Center for Responsible Lending said in a report on the expansion by the banks into fast-cash loans.
In a nutshell, these loans allow regular bank customers to borrow, typically up to $600, on their next scheduled direct deposits of – say, a paycheck, a Social Security check or a pension payment. The bank automatically repays itself and also collects a fee once the deposit arrives in the account.
While acknowledging that such a loan is an expensive form of credit, banks insist that it also serves customers who find themselves in unusual financial straits.
“It is designed to help customers get through an emergency situation – medical, car repairs, etc. – by providing short term credit quickly,” said Peggy Gunn, who directs corporate communication for Wells Fargo’s Minnesota region.
That explanation doesn’t satisfy the folks who counsel Minnesotans with deep financial problems. Several organizations in the state have joined a national call for federal regulators to crack down on the loans, arguing that they are just another form of predatory lending.
“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 said via email. “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.”
Call to federal regulators
Last year, Minnesota Community Action Partnership joined 249 other organizations nationwide in a letter to federal regulators, urging them to stop banks from making such loans. Other Minnesota signatories included Lutheran Social Service of Minnesota, St. Paul-based Jewish Community Action and several law firms and other organizations that work on behalf of immigrants, minorities and low-income families.
Jewish Community Action has seen that “this type of lending targets communities of people who are at a disadvantage in terms of the financial information that they have available to them,” said Carin Mrotz, explaining the organization’s interest in signing the coalition’s letter. She directs the organization’s operations and communications.
In May, the FDIC’s acting chairman, Martin Gruenberg, responded to the coalition’s letter, saying : “The FDIC is deeply concerned about these continued reports of banks engaging in payday lending.” His response was addressed to Lisa Donner, executive director of Americans for Financial Reform, one of the lead organizations in the coalition.
Gruenberg continued: “Typically, these loans are characterized by small-dollar, unsecured lending to borrowers who are experiencing cash-flow difficulties and have few alternative borrowing sources. The loans usually involve high fees relative to the size of the loan and, when used frequently or for long periods, the total costs to the borrower can rapidly exceed the amount borrowed.”
Finally, he said, “I have asked the FDIC’s Division of Depositor and Consumer Protection to make it a priority to investigate reports of banks engaging in payday lending and recommend further steps by the FDIC.
In response to MinnPost’s request about the status of the investigation, FDIC spokesperson LaJuan Williams-Young said last week, “The FDIC does not comment on specific investigations.”
Fees and more fees
Starting in 2008, big banks saw sharp declines in the more than $30 billion they collect each year in overdraft fees, according to The American Banker. Federal officials had tightened rules for the fees, and consumer groups had won court challenges to a practice in which some banks had arranged consecutive overdrafts in a pattern that maximized fees.
Not surprisingly, studies had shown that the overdraft fees fell disproportionately on low-income customers and senior citizens. Now, consumer advocates accuse the banks of trying to make up for the decline of a lucrative revenue source by steering those same customers to high-cost deposit advances.
In their defense, banks said the emergency loans are less expensive than overdrafts.
But overdraft fees are rising again. And research by three professors at the Harvard Business School shows that the availability of payday-style loans did not spare borrowers from costly overdrafts, as banks have claimed, but instead drove them eventually to more overdrafts.
In other words, those borrowers were more likely in the long run to pay expensive advance loan costs and hefty overdraft fees too.
After exploring other possible explanations for that development, the Harvard researchers said that “the presence of this high-cost short-term credit adds to the over-extension of household budgets, and exacerbates the rate at which households overdraw their accounts.”
That study and others like it led the Center for Responsible Lending to conclude: “Because customers must use such a large share of their incoming paycheck to repay the loan, they will often run out of money again before their next payday, forcing them to take out another loan and starting a cycle of borrowing at high rates.”
Debt cycle or safety net?
The banks disagree. They insist 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.
Under Wells Fargo’s Direct Deposit Advance program, some customers who qualify can repay their outstanding advances in small payments over a longer period of time rather than the single lump-sum withdrawal from the next deposit, Gunn said in an email response to MinnPost’s questions.
Cost of Bank Payday Loan
(assuming charge of $10 per $100 advanced)
Length of Loan
Equivalent Annual Percentage rate
10 days
365
14 days
261
One month
120
Source: Center for Responsible Lending
Note: The Federal Deposit Insurance Corporation has urged banks to offer small-dollar, unsecured loans with annualized interest rates of 36 percent or less.
Like U.S. Bank, Wells Fargo said it limits the loans in order to discourage their use as a solution to long-term financial problems. On a website, Wells Fargo says a borrower who has used the advance for six consecutive statement periods must “take a break” for at least one statement cycle, typically a month.
Guaranty Bank sets the same limits, according to its website, and it urges borrowers to seek funds from alternative sources such as credit cards or loans from relatives. “We discourage regular, repeated use of the Easy Advance Service,” it says. At the same time, though, it touts the loans as “convenient” and “quick and easy.”
The banks stress that their short-term advances still are cheaper than typical storefront payday loans.
“Direct Deposit Advance differs from a payday loan in several important ways,” said Gunn at Wells Fargo.
“The Direct Deposit Advance fee is less than the average payday loan fees,” she said. “The industry average on payday loan charges is $17.00 per $100.00 borrowed compared to our $7.50 Advance Fee per $100.00 borrowed.”
The FDIC has called repeatedly over the years for an altogether different option. It wants banks to issue unsecured, small-dollar loans with annualized interest rates no higher than 36 percent. The loans should be structured, it has said, in a way that borrowers could pay down principle over about 90 days rather than as a lump sum withdrawal from their next deposit.
True cost?
Garrison-Sprenger at U.S. Bancorp said that it “is not fitting” to project an annual percentage rate for the current system of deposit advance loans because the charge is a flat fee – at U.S. Bank, $2 per $20 advanced -- which must be repaid from the next direct deposit.
That assertion is where the debate begins.
Attorneys at the National Consumer Law Center say that the fee-based structure is nothing but a disguise for triple-digit annualized interest rates. They calculate that a $400, 10-day loan at U.S. Bank comes at an annualized percentage rate of 365 percent. At Wells Fargo, where the fee is $1.50 for every $20 borrowed, the rate on the same loan would be 274 percent, they calculate.
Such a conversion is slippery to nail down to one rate, though. Let’s say your employer is due to deposit your next paycheck in five days. Your car breaks down today and you take one of these quick-cash loans from your bank to cover the $400 repair costs until payday. Unlikely as it may seem, let’s say that your neighbor has the same bad luck on the same day. Her car breaks down, and her Social Security check isn’t due for 25 days.
The fee would be the same in both cases. But your neighbor got to keep the $400 five times longer than you did. So, effectively, your annualized rate would have been far higher than hers.
Critics of these loans say that neither of you would have been likely to fully settle the debt on that first due date.
“The banks permit customers to remain trapped in these . . . loans month after month, even while they claim that ‘installment options’ or ‘cooling-off periods’ make this high-cost product acceptable,” the Center for Responsible Lending said in its report.
The center found that “bank payday borrowers are in debt for 175 days per year.”
Those borrowers typically were financially vulnerable to begin with, said Pam Johnson at Minnesota Community Action Partnership.
What’s needed instead, she said, is access to low-interest loans that could help such borrowers achieve greater economic stability.
Lacking that access, it isn’t borrowers alone who suffer the consequences of the debt trap.
“Communities are impacted negatively by the loss of assets . . . and the need for increased public assistance,” she said.