April 25 - The Consumer Financial Protection Bureau has issued a report on payday and deposit advance loans finding 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 sustained use of these products which can trap borrowers in debt.
“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.”
The Payday Loans and Deposit Advance Products report is at: http://files.consumerfinance.gov/f/201304_cfpb_payday-dap-whitepaper.pdf.
The report found that payday loans and the deposit advance loans offered by a small but growing number of banks and other depository institutions are generally similar in structure, purpose, and the consumer protection concerns they raise. Both are 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 deposit account.
The CFPB study is one of the most comprehensive ever undertaken on the market. It 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.
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 a sizable share of consumers end up in cycles of repeated borrowing and incur significant costs over time. The study also confirmed that these loans are quite expensive and not suitable for sustained use. Specifically, the study found limited underwriting and the single payment structure of the loans may contribute to trapping consumers in debt.
Loose Lending: Lenders often do not take a borrower’s ability to repay into consideration when making a loan. Instead, they may rely on ensuring they are one of the first in line to be repaid from a borrower’s income. For the consumer, this means there may not be sufficient funds 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.
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.
Sustained Use: 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. For consumers, it is unclear whether they fully appreciate the risk that they may end up using these products much longer 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.
The CFPB has authority to oversee the payday loan market. It began its supervision of payday lenders in January 2012. The CFPB also has authority to examine the deposit advance loans at the banks and credit unions it supervises, which are insured depository institutions and credit unions, and their affiliates, that have more than $10 billion in assets. This report will help educate regulators and consumers about how the industry works and provide market participants with a clear statement of CFPB concerns.
While the study looked at storefront payday lenders, the CFPB will continue to analyze the growing online presence of such businesses. The bureau is also looking at bank and credit union deposit account overdraft programs which provide short-term, small-dollar, immediate access credit services. The CFPB will publish initial results from this overdraft study later this spring.
To help educate consumers about payday and deposit advance loans, today the CFPB updated its Ask CFPB web tool to assist consumers with their financial questions about these products.
A factsheet about payday and deposit advance loans is available at: http://files.consumerfinance.gov/f/201304_cfpb_payday-factsheet.pdf.