High-cost bank loans a step in the wrong direction

U.S. Bank recently introduced a new small-dollar loan product. By the bank’s own description, it’s a high-cost product, at 70-88% APR.

High-cost loans by banks offer a mirage of respectability. A component of this illusion is the misguided idea that limiting payment size to 5% of gross income means the loan is affordable for most borrowers. But these products will be unaffordable for many borrowers and ultimately erode protections from predatory lending across the board.

A few years ago, a handful of banks were making triple-digit interest rate, unaffordable payday loans that drained consumers of half a billion dollars a year. Among their many victims was Annette Smith, a widow who relied on Social Security for her income. Annette testified before Congress about a Wells Fargo “direct deposit advance” for $500 that cost her nearly $3,000. Payday loans are aptly described as “a living hell.”

Annette’s experience was hardly an aberration. Over half of deposit advance borrowers had more than ten loans annually. Additionally, deposit-advance borrowers were seven times more likely to have their accounts charged off than their counterparts who did not take out these loans.

But the banks setting these debt traps dug in, defending them staunchly until regulators’ 2013 ability-to-repay guidelines finally led to their discontinuance — with one notable exception, Fifth Third, which continues to make balloon-payment payday loans.

Today, the threat of widespread high-cost bank loans looms large again — not so much thanks to regulatory certainty as to a deregulatory environment that’s proven eager to answer the siren song of the bank lobbyists.

Late last year, new leadership at the Office of the Comptroller of the Currency rescinded the guidance that had precipitated the end to debt trap balloon-payment loans from Wells Fargo, U.S. Bank and others. And in May, the agency issued installment loan guidelines without adequate guardrails around ability-to-repay or price. The Federal Deposit Insurance Corp. and Federal Reserve officials are under intense pressure to follow suit. The National Credit Union Administration is also considering a dangerous new program, opposed by many groups, that could facilitate unlimited flipping of short-term high-cost loans, as well as unaffordable longer-term loans.

Meanwhile, consumer, civil rights and faith groups across the country have continued to voice strong opposition to bank lending in excess of 36% APR, registering concerns with regulators and banks alike.

But U.S. Bank has stepped through the door opened by the OCC by announcing its product “Simple Loan,” a three-month installment loan of up to $1,000 at an APR that would be illegally high in approximately 31 states plus D.C. if made by a nonbank lender. Their rate is also unpopular. For instance, even a lower rate of 60% is deemed too high by a whopping 93% of North Carolina voters.

A supposed safeguard of the U.S. Bank product is limiting monthly payments to 5% of gross monthly income. But data simply do not support that this metric — which shows a puzzling disregard for the expenses of financially distressed consumers — is a meaningful affordability standard for high-cost loans. In fact, federal government research on more than one million loans found default rates of more than 38% at payment-to-income ratio of 5% or less.

Common sense doesn’t support this notion either. Payday borrowers have very low incomes, are typically already overburdened by credit, and have average credit scores in the low 500s. And history has shown us that, rather than substitute for other high-cost products, additional high-cost loans push already constrained borrowers further into unsustainable debt.

Payday loans, including deposit advance loans, have not been shown to reduce overdraft fees. In fact, payday loans are consistently shown to trigger overdraft fees.

Similarly, when banks were making deposit advance loans at price points of half or two-thirds that of storefront lenders, with annual volume of $6.5 billion (most of it, like storefront payday loan volume, generated by the previous unaffordable payday loan), there was no evidence that they put a dent in nonbank payday lending.

High-cost installment loans also often add to already unsustainable debt burdens. In Colorado, where installment loans average 129% APR, a default or delinquency occurred in 23% of all 2016 loans. Even when the loans are repaid, focus group participants there describe how these loans often compounded their already unmanageable debt burdens.

Thus, we know of no evidence suggesting that high-cost bank installment loans will drive down nonbank payday lending. They do, however, threaten a race to the bottom as nonbank lenders will seek to loosen state usury laws to “compete” with banks.

Banks and credit unions do not need special passes to make reasonably priced loans. Many depositories make affordable installment loans, and around 650 credit unions lend under the current rules of the NCUA payday alternative loan program. There are also 76 million open subprime credit cards, up steadily since it was 59 million in 2012.

The key principle is this: Credit must be affordable, or it harms more than it helps. And extremely high interest rates on loans to financially vulnerable consumers cannot be justified as everyday risk-based pricing. The rates, instead, are a red flag signaling a business model not based on ability to repay. Banks making loans through checking accounts have the added leverage of holding the customer’s bank account. This can ease their ability to profit off loans, even if they leave borrowers without enough money to meet basic needs.

The most efficient and effective way to ensure affordability is through interest rate caps of no higher than 36%. This idea is strongly supported by Americans across the political spectrum, as seen in Arizona, Ohio, Montana and South Dakota, where voters in recent years have voted overwhelmingly in favor of this rate limit. Fifteen states and D.C. have these caps on short-term loans, many more have them on installment loans, and federal law establishes the cap for military service members. The FDIC already has installment loan guidelines advising a cap of 36% — and it should reinforce them. Other regulators should join. And the NCUA should not expand its program in unsound ways. These actions will help ensure that depositories help rather than harm their account holders, and that loans enable dreams and not nightmares.