by Jeff Sovern
Deposit advance loans are banks' answer to payday loans. Just like payday loans, they tend to be for short periods and high interest rates. And just as with payday loans, consumer advocates fear that consumers get trapped in them, in the sense that many borrowers can't come up with the money to pay off the principal, and so just keep rolling them over and over–thereby paying the high interest rates for a succession of short-term loans, rather than paying a lower interest rate for a longer term loan. Regulators have responded by proposing limits to such loans. Last week, the Wall Street Journal reported that some banks issuing deposit advance loans are threatening to stop making the loans if the regulators carry through on their proposal.
That raises the question of whether it would be a bad thing if the banks did so. No doubt many consumer advocates would see it as a positive for banks to stop making the loans. On the other hand, as CFPB director Richard Cordray has noted, there is a demand for these products. What would the borrowers who are now taking out such loans do if they could no longer get them? If they ended up with payday lenders, it's hard to see how that would be an improvement. If, on the other hand, they found a cheaper way to borrow (credit cards? family member?) that would be a positive, but if they had access to such a source of funds, presumably they would already choose it over the high cost borrowing–though that assumes they recognize it as cheaper. If they couldn't borrow from another source, and so did without the money, would that be better? Does the answer depend on what they would have used the money for and whether they wouid have been ensnared by a debt trap? And who should make that judgment? The consumer or regulators? All this raises one of the most fundamental questions in consumer protection law: should consumers be able to make these judgments for themselves, or does the fact that so many consumers have made such judgments poorly mean that regulators should make the judgment for them?
When Elizabeth Warren first proposed the CFPB, she often drew an analogy to a defective toaster. She said you can't buy a defective toaster that can burn down your house, but you can take out a bad mortgage that will cost you your home. Are these loans like the defective toaster, in that consumers can't see them for what they are? I envy the certainty of those who believe they know the answer.
America is trapped between the unfairness of payday loans and the reality of the poverty in much of the working poor. After spending the last 15 years as a CRA officer teaching financial literacy to more than 5,000 low income I learned that many Americans have spent years living paycheck to paycheck. They know they need to save but they cannot. One late child support payment can cause a single mother to resort to obtaining a payday loan to pay the school cafeteria bill for her child. The CFPB is wrong about consumers knowledge of payday. By far the majority of the families I taught understand payday loans are expensive and difficult to repay but they also believed they have no other choice.
Data from the payday industry indicates that most loans are used for car repairs and family emergencies. These are loans as a last resort. Many of the households know they are at times cheaper than overdrafts. Over and over I heard “I did not want to go” but learned these loans are used to keep the families financially afloat. Unfortunately, for most of the families that end up in the payday loan cycle there is not exit. They ultimately cannot repay the loans and many then write checks that are then covered by “bounce protection” to repay the loan. This ultimately leads for many households to overdrafts they cannot cover and they forced out of the banking system to become part of the great “unbanked”. Then I see them in the “Credit Improvement workshops”.
Mr. Sovern is right in one respect, if we make payday lending a “crime” what and who will replace it? What will I tell the families attending my financial literacy classes when they ask: “Where do we get money when the check is late?” The payday yields and returns are criminal. The CFPB is nearsighted about the fix, and our regulators have the mistaken notion that by encouraging Banks to open new deposit accounts for the “unbanked” will magically fix the problem. Before we can face the answer we need to face the problem