Stay away from payday and deposit advance loans: Report shows they trap consumers in debt

A report on payday and deposit advance loans found 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 continued use of these products, which can trap borrowers in debt, according to a report by the Consumer Financial Protection Bureau.

The report found that payday loans and the deposit advance loans offered by a small but growing number of banks and other financial institutions are similar and raise the same kind of the consumer protection concerns

Both are described as a way to bridge a cash flow shortage between paychecks or other income. They offer easy accessibility, especially for consumers who may not qualify for other credit.

The loans generally have three features:

• They’re small-dollar amounts.

• Borrowers must repay them quickly.

• They require that a borrower repay the full amount or give lenders access to repayment through a claim on the borrower’s deposit account. 

Key findings

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. This means that many consumers end up in cycles of repeated borrowing and incur significant costs over time. The study also confirmed that these loans are expensive and not suitable for continued use.

Loose Lending

Lenders often don’t take a borrower’s ability to repay into consideration when making a loan. Instead, they may rely on ensuring they’re one of the first in line to be repaid from a borrower’s income.

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.

Continued use

The loose underwriting, the rapid repayment requirement, and the high costs all may contribute to turning a short-term loan into an expensive, long-term loan.

Bureau action

The bureau, which has authority to regulate the payday loan market and deposit advance loans at the banks and credit unions it supervises, is in the process of figuring out the right approach to protect consumers and ensuring that they’ll have access to a small loan market that is fair, transparent, and competitive, Richard Cordray, director of the bureau, said.

While the study looked at storefront payday lenders, the bureau will continue to analyze online payday lenders.

The bureau offers an Ask CFPB web tool to help consumers with their questions about payday and deposit advance loans.

A factsheet about payday and deposit advance loans is available at: http://files.consumerfinance.gov/f/201304_cfpb_payday-factsheet.pdf.

Copyright 2013, Rita R. Robison, Consumer Specialist