A report on payday and
deposit advance loans found that for many consumers these products lead to a
cycle of indebtedness.
Loose lending
standards, high costs, and risky loan structures may contribute to the
continued use of these products, which can trap borrowers in debt, according to
a report by the Consumer Financial Protection Bureau.
The report found that payday loans and the
deposit advance loans offered by a small but growing number of banks and other
financial institutions are similar and raise the same kind of the consumer
protection concerns
Both are described as a way to bridge a cash flow
shortage between paychecks or other income. They offer easy accessibility,
especially for consumers who may not qualify for other credit.
The loans generally have three features:
- They’re small-dollar amounts.
- Borrowers must repay them quickly.
- They require that a borrower repay the full
amount or give lenders access to repayment through a claim on the borrower’s
deposit account.
Key findings
Payday
and deposit advance loans can become debt traps for consumers
The report found many
consumers repeatedly roll over their payday and deposit advance loans or take
out additional loans, often a short time after the previous one was repaid.
This means that many consumers end up in cycles of repeated borrowing and incur
significant costs over time. The study also confirmed that these loans are expensive
and not suitable for continued use.
Loose Lending
Lenders often don’t
take a borrower’s ability to repay into consideration when making a loan.
Instead, they may rely on ensuring they’re one of the first in line to be
repaid from a borrower’s income.
Risky loan structures
The risk posed by the
loose underwriting is compounded by some of the features of payday and deposit
advance loans, particularly the rapid repayment structure. Paying back a lump
sum when a consumer’s next paycheck or other deposit arrives can be difficult
for an already cash-strapped consumer, leading them to take out another loan.
High costs
Both payday loans and
deposit advances are designed for short-term use and can have high costs. These
high costs can add up – on top of the already existing loans that a consumer is
taking on.
Continued use
The loose
underwriting, the rapid repayment requirement, and the high costs all may
contribute to turning a short-term loan into an expensive, long-term loan.
Bureau action
The bureau, which has
authority to regulate the payday loan market and deposit advance loans at the
banks and credit unions it supervises, is in the process of figuring out the
right approach to protect consumers and ensuring that they’ll have access to a
small loan market that is fair, transparent, and competitive, Richard Cordray,
director of the bureau, said.
While the study looked
at storefront payday lenders, the bureau will continue to analyze online payday
lenders.
The bureau offers an Ask CFPB web tool to help
consumers with their questions about payday and deposit advance loans.
A factsheet about payday and deposit advance
loans is available at: http://files.consumerfinance.gov/f/201304_cfpb_payday-factsheet.pdf.
