Most credit unions have been investing the majority of their compliance resources in trying to understand and implement the historic changes to consumer protection laws for mortgage lending. But now the Consumer Financial Protection Bureau has issued a white paper that discusses its study on the short-term, small-dollar loan market that provides payday loans and deposit advance loans. Payday lending takes place in nondepository financial institutions and is mostly regulated by state law. However, many credit unions make deposit advance loans, as well as offering courtesy overdraft programs, with the goal of helping their members. Now, however, it is clear that the bureau and thus other federal regulators will be looking at these products closely in the coming months and years.
Context of the Study
The CFPB gathered data from a number of depository institutions and included consumers who were either eligible to take an advance during the first month of the study period or eligible during subsequent months if they had been eligible sometime during the quarter prior to the beginning of the study period. About half of the institutions’ consumer deposit accounts were eligible for deposit advances. The sample contained more than 100,000 eligible accounts, with roughly 15 percent of accounts having at least one deposit advance during the study period. The study compared deposit advance users and consumers who are eligible for — but did not take — any advances, as well as deposit advance users with varying levels of use.
The bureau used this sampling methodology so that patterns measured could not be attributed to any specific institution. According to Bureau Director Richard Cordray “the purpose of [the] field hearing, and the purpose of all our research and analysis and outreach on these issues, is to help us figure out how to determine the right approach to protect consumers and ensure that they have access to a small loan market that is fair, transparent, and competitive.” He went on to say the bureau was “attempting to gather data to get a complete picture of the payday market and its impact on consumers,” including how consumers “are affected by long-term use of these products.”
What Is a Deposit Advance Product?
A deposit advance product is a small-dollar, short-term loan that a depository institution (credit union) makes available to a member whose deposit account reflects recurring direct deposits. The member is allowed to take out a loan, which is to be repaid from the proceeds of the next direct deposit. These loans typically have high fees, are repaid in a lump sum in advance of the member’s other bills, and often do not utilize fundamental and prudent underwriting practices to determine the member’s ability to repay the loan and meet other necessary financial obligations.
The Bureau’s Conclusions
The CFPB’s conclusions are based on the statistical findings in the report on deposit advance products:
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Deposit advances had a median of just under $3,000 in average monthly deposits.
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Deposit advance users tended to have a lower volume of payments and other account withdrawals than eligible nonusers. However, deposit advance users tended to conduct a larger number of account transactions than eligible nonusers, particularly debit card transactions.
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A significant share of deposit advance borrowers took a sizable volume of advances during the 12-month study period. More than half of deposit advance users in our sample took advances totaling more than $3,000 and more than a quarter (27 percent) of deposit advance borrowers took advances totaling more than $6,000 over 12 months. The two highest usage groups accounted for 64 percent of the total dollar volume of advances and more than half (55 percent) of the total number of advances extended. In contrast, the borrowers who used $1,500 or less in advances during the same time period accounted for less than 10 percent of the total dollar amount and number of advances.
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A typical fee is $10 per $100 borrowed. This fee would imply an annual percentage rate of 304 percent given a 12-day duration. A hypothetical lower fee of $5 per $100 advanced would yield an APR of 152 percent, while a hypothetical higher fee of $15 per $100 advanced would yield an APR of 456 percent with the same 12-day term. The APR will vary significantly depending on the duration of a particular advance balance episode and the fee charged by an individual institution.
Consumer Protection Concerns
The findings in the report raise substantial consumer protection concerns for the bureau. It intends to continue its inquiry into small-dollar lending products to better understand the factors contributing to the sustained use of these products by many consumers and the light to moderate use by others. The bureau plans to analyze the effectiveness of limitations, such as cooling-off periods, in curbing sustained use and other harms. The bureau is separately analyzing borrowing activity by consumers using online payday loans
While it is understood there is a need for short term small loans and many consumers only use them occasionally, the CFPB has concluded that the products may become harmful for consumers when they are used to make up for chronic cash flow shortages. The bureau noted that a sizable share of payday loan and deposit advance users conduct transactions on a long-term basis, suggesting that they are unable to fully repay the loan and pay other expenses without taking out a new loan shortly thereafter.
Over half of deposit advance users in the sample took out advances totaling over $3,000. This group of deposit advance users tended to be indebted for over 40 percent of the year, with a median break between advance balance episodes of 12 days or less. Therefore, it seems clear to the bureau that many consumers are unable to repay their loan in full and still meet their other expenses.
The CFPB is not sure whether consumers understand the costs, benefits, and risks of using these products. On their face, these products may appear simple, with a set fee and quick availability. However, the fact that deposit advances do not have a repayment date, but rather are repaid as soon as qualified deposits are received, adds a layer of complexity to the product that consumers may not effectively grasp.
Moreover, the bureau thinks that consumers may not appreciate the substantial probability of being indebted for longer than anticipated and the costs of such sustained use. To the extent these products are marketed as a short-term obligation, some consumers may misunderstand the costs and risks, particularly those associated with repeated borrowing.
The bureau is concerned that the current repayment structure of payday loans and deposit advances, coupled with the absence of significant underwriting, likely contributes to the risk that some borrowers will find themselves caught in a cycle of high-cost borrowing over an extended period of time.
Furthermore, the bureau noted that these products are represented as being appropriate for consumers who have an immediate expense that needs to be deferred for a short period of time and will have a sufficient influx of cash by the next pay period to retire the debt — and to pay the significant borrowing costs. However, the bureau said it appears that lenders do not attempt to determine whether a borrower meets this profile before extending a loan. Lenders may instead rely on their relative priority position in the repayment hierarchy to extend credit without regard to whether the consumer can afford the loan. According to the report, this position, in turn, trumps the consumer’s ability to organize and prioritize payment of debts and other expenses. Other structural and usage characteristics may also play a material role in harm experienced by consumers. Based on their analysis, we might expect more disclosure rules about these products even though they are covered by a plethora of regulations now.
NCUA Guidance
In September 2012, the National Credit Union Administration approved an advanced notice of proposed rulemaking on the agency’s payday-alternative loan (PAL loan) rule. The NCUA board was reviewing its regulation governing payday-alternative loans, formerly known as short-term, small amount loans. The board intended to improve the regulation to encourage more federal credit unions to offer PAL loans and believed it may be necessary to amend the regulation.
The PAL Rule
On September 16, 2010, the NCUA board amended its general lending rule to enable federal credit unions to offer PAL loans, previously referred to as short-term, small-amount loans, as an alternative to predatory payday loans. PAL loans can help certain members to break free of their dependency on high-cost payday loans. To help FCUs afford to make PAL loans, which tend to have higher rates of default than mainstream loan products, the PAL rule permits FCUs to charge a higher rate of interest for PAL loans if certain conditions are met.
The current rule, 12 CFR 701.21, allows federal credit unions to charge a rate no higher than 1,000 basis points above the agency-set loan interest rate cap, now 18 percent. The rule permits an application fee of up to $20, requires that loan amounts are no lower than $200 and no higher than $1,000, and among other things, prohibits more than three such loans to one member in any rolling six-month period.
NCUA sought comments on the application fee and any other comments about the current regulation. The agency included specific questions for the industry and the general public to consider. Although the comment period expired on the notice, a proposed rule was never issued. You can read it at http://www.gpo.gov/fdsys/pkg/FR-2012-09-27/pdf/2012-23718.pdf.
