We all run a little short of money from time-to-time and there are both good and bad ways of dealing with the problem. Among the worst, according to a study by the Consumer Financial Protection Bureau (CFPB), is depending on payday and deposit advance loans.
According to the study, these products can lead consumers to a cycle of indebtedness.
“This comprehensive study shows that payday and deposit advance loans put many consumers at risk of turning what is supposed to be a short-term, emergency loan into a long-term, expensive debt burden,” said CFPB Director Richard Cordray. “For too many consumers, payday and deposit advance loans are debt traps that cause them to be living their lives off money borrowed at huge interest rates.”
Consumer protection concerns
According to the CFPB report, payday and deposit advance loans offered by a growing number of banks are generally similar in structure, purpose, and the consumer protection concerns they raise.
Typically described as a way to bridge a cash flow shortage between paychecks or other income, they offer quick and easy accessibility, especially for consumers who may not qualify for other credit.
The loans generally have three features: they are small-dollar amounts; borrowers must repay them quickly; and they require that a borrower repay the full amount or give lenders access to repayment through a claim on the borrower’s checking or savings account.
Renee of New Orleans says she found herself trapped when she agreed to a loan of $400 with Cash Direct Express. "Like other payday loan company I delt with you can reduce your payments to 4 payments," she writes in a ConsumerAffairs post. "But this company took $100 for 4 paydays and then begin to take monies owed on the principal $40 at a time and then charged interest on the balance. the first pay was $40 + $120 then $40 + $95. I call to check the balance it was $354 so on $400 dollars I paid $1069. How do company get away with this?"
Not uncommon is the case of Andrew of Palm Springs, Calif., who says he borrowed $300 from EZPayDayCash.com, which offered a 6-month payback at $50 per month.
But, "the fine print charges you $75 per month to do it," he writes in a ConsumerAffairs post. "After 6 months you will repay the original loan of $300 along with almost $450 in fees. OMG! Didn't I understand what I was signing? Well, apparently not... and I'm a pretty bright guy. I didn't realize it on my bank statement initially and got a chuckle out of it as they explained it to me. Each time I asked a question they replied by chanting, 'You agreed, you agreed, all explained, you agreed.' And I guess they're right, which is why I am stunned by the smooth way they pulled the wool over my eyes and am now urging you to run away, run away, run away."
The study, which looked at a 12-month period with more than 15 million storefront payday loans and data from multiple depository institutions that offer deposit advance products, found:
- 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.
- Lenders often do not take a borrower’s ability to repay into consideration when making a loan. For the consumer, this means there may not be enough money left after paying off the loan for expenses such as for their rent or groceries -- leading them to return to the bank or payday lender for more money.
- 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.
- Both payday loans and deposit advances are designed for short-term use and can have very high costs. These high costs can add up -- on top of the already existing loans that a consumer is taking on.
- The loose underwriting, the rapid repayment requirement, and the high costs all may contribute to turning a short-term loan into a very expensive, long-term loan.
It's unclear whether consumers fully appreciate the risk that they may end up using these loans over a much longer period of time than the original term. Or, that they may end up paying fees that equal or exceed the amount they borrowed, leading them into a revolving door of debt.