Breaking the cycle of payday loan 'trap'

WASHINGTON — Tellers at the North Carolina State Employees' Credit Union noticed a troubling change several years ago: The first people in line on payday were high-cost lenders, waiting to cash checks from credit union members.
A glance at the records showed thousands of credit union customers were turning to payday outlets for small loans to be repaid with their next paychecks. Such products typically carry annual fees of 300% to 1,000%. Many strapped borrowers repeatedly roll over the loans, sinking deeply into debt.

To wean its members from fast cash advance payday loan, the State Employees' Credit Union (SECU) in 2001 introduced a short-term loan that has a 12% annual interest rate, a maximum limit of $500, requires borrowers to repay via direct deposit of their paychecks and put 5% of loan proceeds in savings accounts. Each month, more than 40,000 people use the product, which has a maximum 31-day term. Overall, members have accumulated $10 million in savings accounts.

"We wanted to find a way to get our members out of this trap," says Jim Blaine, SECU president. "We have a couple of our vice presidents using it, a vice chancellor of a university. ... It's not just a poor person's product."

The SECU is one of a growing number of credit unions now offering products specifically designed to combat payday, or cash advance, lending, which soared in the 1990s even as the nation experienced record economic growth.

loan online payday quick lending has become a $40 billion annual business (in loan volume) with more than 22,000 U.S. outlets, according to the Community Financial Services Association of America, the industry's trade group. By comparison, Starbucks has 8,624 U.S. locations and McDonald's about 14,000.

Mainstream lenders were initially slow to react, but more than 1,000 of the 9,000 U.S. credit unions now have products designed as alternatives to payday loans, says Dan Mica, president of the Credit Union National Association. That includes the Prospera Credit Union in Appleton, Wis., which started a program in a Goodwill Industries thrift store last year after Prospera CEO Ken Eiden noticed people going from the store to a payday lender across the way. Eiden says Prospera has already lent $1 million via the product.

Obstacles to alternative loans

Still, there are obstacles to alternative loans. Credit union officials fret about the stigma of being labeled a payday lender, albeit a lower-cost one. The SECU's Blaine says his short-term loans are his most profitable product, but Mica says given the poor credit quality of borrowers, many are break-even or community-service products.

Federal Deposit Insurance Corp. Chairman Sheila Bair, while she was a professor at University of Massachusetts in 2005, wrote a paper suggesting one reason banks and credit unions may have held back from short-term lending was to avoid undercutting highly profitable, bounced-check protection programs that have become de facto low cost payday loan protection for some customers — with similarly high fees.

And Yolanda McGill of North Carolina's Center for Responsible Lending worries regulators could view credit union competition as a solution in itself, making them less likely to clamp down on payday lenders. She also says the ultimate goal must be to get people out of the short-term loan trap.

In Oregon, regulators say it's not either-or. A state law pushed by consumer advocates that takes effect in mid-2007 puts a 36% annual cap on payday loans. In the meantime, officials are working with such non-profits as Our Oregon and credit unions to promote alternative loans, including putting informational fliers in food bank boxes.

"If all we do as regulators is say, 'We're going to cut back on this, cut back on that,' (high-cost lending) will pop up someplace else," says Cory Streisinger, director of the Oregon Department of Consumer and Business Services. "We want to say, 'Here are some other options.' "

The effort has helped Ruby Stoker, 36, of Junction City, Ore. She and her husband, Ronald, got into trouble after taking out an $800 payday loan that, in a matter of months, morphed into four loans with an overall balance of $2,200. Stoker, who was carrying some loans with annual fees of 800%, now has a 13% credit union loan with a stretched-out repayment plan.

"They don't even do a credit check. They just use your paycheck. ... You're done in 10 or 15 minutes," Stoker says. "We're both graduates from college," adds Stoker. "It's not (that) you wake up in the morning and say, 'Let's go get ourselves into debt and bury ourselves to the point where we have to make a choice between paying the rent and eating.' "

The country has a long history of high-cost lending. There are a variety of theories for the recent growth, from banking deregulation to savvy marketing and consumers' desire for convenience. Mica expects there will soon be more than 40,000 payday outlets.

A typical payday product might be a two-week loan for $200 with a $30 fee, which translates into an effective annual percentage rate of 390%. Lenders provide immediate cash in return for a postdated check for the loan plus the fee, often with no background credit analysis.

Steven Schlein, spokesman for the Community Financial Services Association, says that borrowers often choose payday lenders to avoid high bounced-check or credit-card late fees from mainstream lenders, which can be as pricey as some of their products on an annual basis. He said the industry hasn't felt much impact from the credit union products.

"Only a few credit unions to our knowledge are offering two-week loans at low denominations," Schlein says. "We encourage them to. We're an entrepreneurial business who operates in a free market."

Research cited by Schlein's group and other analysts indicates many payday customers are repeat borrowers. For example, the Washington State Department of Financial Institutions, based on a voluntary survey of 66% of the state's payday lenders, found about half of borrowers took out six or more loans in 2004 and 25% took out a dozen or more.

States are cracking down on payday lenders, imposing fee caps and limits on the number of loans a borrower can have. The Department of Defense wants a 36% annual limit, given huge problems with payday lending near military bases.

Lenders, in response, are finding ways around the tougher rules. In Oregon, some same day no fax payday loan firms have applied to switch to a different form of charter to circumvent the new law. State officials may also have to ask the Legislature for action to regulate Internet sales of payday loans.