An Alternative to Payday Loans, but It’s Still High Cost

U.S. Bank, one of the country’s biggest banks, has again begun offering customers small, high-cost loans, saying the loans now have safeguards to help keep borrowers from getting in over their heads.

The loans, between $100 and $1,000, are meant to help customers deal with unexpected expenses, like a car repair or a medical bill, said Lynn Heitman, executive vice president of U.S. Bank consumer banking sales and support. But the fees equate to an annual interest rate of about 70 percent.

The loans were created to be an alternative to payday loans, the small, short-term, very-high-cost loans — with interest rates sometimes as high as 400 percent — that typically must be repaid in full from the borrower’s next paycheck. Payday loans are often taken out by people whose credit scores are too low for traditional loans or credit cards.

U.S. Bank and several other institutions, including Wells Fargo and Regions Bank, for a time offered so-called deposit advance loans, which typically were costly and had to be repaid in a lump sum when the customer’s next paycheck was deposited. Banks abandoned the loans after regulators clamped down on them in 2013.

This year, however, a major financial regulatory agency, the Office of the Comptroller of the Currency, opened the door for banks to offer small loans.

U.S. Bank says its new “simple” loans are more consumer-friendly. The loans are repaid in three equal monthly installments, rather than in a lump sum, Heitman said, and customers must wait 30 days after paying off one loan before applying for another. The bank will not deduct a scheduled payment if it would overdraw a customer’s account, she said. That way, the customer won’t incur overdraft or insufficient-funds fees.

On a $400 loan, the fee would be $48, which equates to an annual interest rate of about 71 percent, according to an example on the bank’s website.

Consumers apply for the loans online or via a smartphone app, and a decision is made quickly using automated “underwriting,” or financial review.

Customers must have a checking account with U.S. Bank for at least six months before applying for the loans, and must have recurring direct deposits. The bank runs a credit check before approving loans, and reports the borrower’s payments to credit bureaus, which can help customers build a credit history. Heitman declined to say what minimum credit score was required, but said the loans were available to a “broader” range of customers than its traditional loans.

Reaction to the new loans has been mixed. Nick Bourke, director of consumer finance at the Pew Charitable Trusts, which supports making affordable small loans available to consumers with appropriate safeguards, said the new loan appeared promising. When the loan program was announced, he tweeted that it was a “game changer.” Pew opposes payday loans, but has called for mainstream banks to offer less risky small loans to help consumers when they hit financial potholes. The U.S. Bank loans include some features that Pew recommends, Bourke said, such as limiting loan payments to 5 percent of the borrower’s monthly income and avoiding overdraft fees.

While the loans are relatively expensive, they are far less costly than alternatives like payday loans or auto title loans.

“It’s a great first step,” Bourke said.

According to Pew’s research, 12 million people a year take payday loans. If borrowers can’t make the payment, they often pay more fees to renew the loan. Payday borrowers, Pew found, spend an average $520 in fees to repeatedly borrow $375.

U.S. Bank’s new loans cost $12 for each $100 borrowed, when payments are automatically debited from a customer’s account. The fee is $15 per $100 if a customer opts out of automatic payments.

“This is a high-cost loan,” Heitman acknowledged, adding that the bank was being “transparent” about the fees. The bank has received strong positive feedback from customers, she said, who say they find the loan terms easy to understand.

The Center for Responsible Lending, an advocacy group, was skeptical of the value of U.S. Bank’s offering, saying the loans are still too expensive for most low-income people, many of whom are already burdened by debt and have little wiggle room to take on more.

“It’s a step in the wrong direction,” said Rebecca Borné, the center’s senior policy counsel.

And while the bank won’t let the customer’s checking account be overdrawn by a loan payment, she said, the payment itself could cause the account’s balance to shrink so low that subsequent bills cause overdrafts.

“At the end of the day,” Borné said, “a bank that pays its depositors less than 3 percent interest should lend that money for a whole lot less” than an interest rate of 70 percent or more. Here are some questions and answers about short-term loans:

A. Heitman said that if an automatic payment would overdraw a customer’s account, the bank would wait until the next scheduled payment date to make a withdrawal. In the interim, the bank uses its “internal” collection processes, such as contacting the customer by text and email, to encourage the borrower to make the missed payment, she said. No late fee is charged. She declined to say whether the bank would refer past-due accounts to outside bill collectors at some point.

A. Fifth Third Bank, based in Cincinnati, offers what it calls “early access” loans — essentially, a paycheck advance — of up to $1,000 for customers who have had accounts at the bank for at least a year. The bank charges a fee of 3 percent of the advance, which must be repaid in full with the customer’s next deposit. In part because the loans aren’t repaid in installments, they don’t meet Pew’s criteria for “safe and affordable” small loans, Bourke said.

A. Some credit unions offer “borrow and pay” programs, in which part of customers’ payments go into a savings account that they can draw on once the loan is repaid. Ideally, consumers should try to amass a cash cushion that they can use in an emergency, avoiding the need to borrow at high cost, said George Barany, director of the America Saves program, a savings initiative of the nonprofit group Consumer Federation of America.

Consumers should set an attainable goal — say, $400 to $500 — and put away a small amount from each paycheck until it is reached, he said. It’s best, if possible, to have a fixed amount — even $25 — automatically deposited in your savings account. Some employers will split your paycheck between your checking and savings accounts if you ask. You can also ask your bank to set up an automatic transfer from your checking account to your savings account each month.