Trying to outpace regulators, the payday loan industry is shifting from lump sum payment to installment repayment. However, the loans still pose huge risks for borrowers, the Pew Charitable Trusts said on Thursday.
“Most installment payday loans have payments that exceed what typical borrowers can afford,” Pew said in a briefing note. “Unaffordable payments can lead to the same kinds of problems that exist in the conventional lump-sum loan market: frequent reborrowing, overdrafts, and the need for a cash injection to repay debt.”
Expanding on the case, a senior Pew executive said the NCUA Alternative Payday Loan program avoids many of the pitfalls of payday loans, but the program still eclipses the rest of the industry.
“Revenue and automation haven’t produced the scale needed to take credit union members back from payday lenders,” said Alex Horowitz, a senior executive with Pew’s Small Dollar Loan Program.
He said while 170,000 PAL loans were made in 2014, many more payday loans – 100 million – were made that year.
Pew said regulators should pass regulations that encourage more banks and credit unions to offer alternatives to the loans offered by many payday lenders.
Through its PAL program, the NCUA allows federal credit unions to charge an interest rate of 1,000 basis points above the maximum interest rate set by the NCUA board and an application fee not to exceed not $20. The loan must be structured with a term of 46 days to six months and include substantially equal and amortizing payment terms at regular intervals. No prepayment penalty is allowed. Under the program, the minimum loan size is $200 and the maximum loan size is $1,000.
The CFPB released proposed rules in June to regulate payday loans; these rules would require loans to be repaid in installments. Credit unions had been pushing for a full exemption from these rules.
The CFPB refused to do so. However, the proposed rules include an exemption for the PAL program.
For most borrowers to be able to repay the loans, they shouldn’t be required to make payments totaling more than 5% of their income, Pew said.
The financing costs must be spread over the term of the loan and the term of the loan must be sufficient to allow repayment of the loan.
And while the CFPB does not have the authority to set an interest rate on loans, state regulators should, he noted. Regulators should also lower loan prices to allow more traditional lenders to enter the market, Pew said.
“Banks and credit unions have great competitive advantages over payday lenders and auto titles because they are diversified businesses that cover their overhead costs by selling other products, could lend to their own customers rather than pay to attract new ones, have customers who make regular deposits into their checking accounts and have a low cost of funds,” Pew said.
As a result, these financial institutions are likely to be able to offer loans at prices six to eight times lower than other payday lenders, according to Pew.
These financial institutions could profitably provide small loans at double-digit APRs, at prices six to eight times lower than those offered by payday lenders, Pew said.
However, Pew also said underwriting that requires staff time or a large amount of documentation would make loans too expensive for banks and credit unions to offer.