More Banks Offering Payday Loan Alternatives

Inside Subprime: Sept 12, 2018

By Lindsay Frankel

A major US bank headquartered in Minneapolis has unveiled a new product intended to fill the short-term loan needs of its customers.  The product is designed to compete with payday loans by using a digital process to offer the product at a much lower cost than traditional payday loans, which typically carry triple digit interest rates. Consumer-advocacy groups contend that there is a need for safe access to credit and have urged banks to offer loans that compete with predatory loan products. In addition, the Office of the Comptroller of the Currency (OCC) issued a statement in May encouraging banks to offer affordable installment loans to customers.

This new product allows borrowers to take out a loan between the amounts of $100 and $1,000, and the loan must be paid back over the course of three months in three total payments. Existing customers with a savings or checking account can opt to repay the loan via autopay, for which the bank would charge $12 for every $100 borrowed. If the customer chooses to repay the loan by check, the charge is increased to $15.

Even if the borrower pays back the loan manually, the cost to borrow $300 for three months is only $45. This is much less than the average cost of payday loans, according to Pew Charitable Trusts. For example, a $300 payday loan in Texas costs an average of $70 per 2-week pay period. That means it would cost roughly $420 to borrow $300 from a payday lender in Texas for three months. These risky, high-cost loans are unaffordable for most borrowers, and consumer advocates welcome the development of less costly bank alternatives.

Interest rates this low would not have been possible before the advent of digital banking. But new technology has made it possible for banks to profit from small-dollar loans without charging exorbitant interest rates.

One caveat is that the bank will only offer the product to borrowers with a credit history. Frequently, borrowers who lack established credit turn to payday loans because they lack alternative options. Unfortunately, this product will not serve this segment of the population. However, the bank has arranged for credit reporting agencies to use the borrower’s repayment of the loan to build credit, so this product could provide customers with future access to even lower-cost alternatives like credit cards.

This bank-offered option could potentially save borrowers billions in interest and fees. Should other banks follow suit, more low-income families would have access to safe and responsible methods of borrowing money. 81 percent of payday loan borrowers would rather borrow from their bank if given the option, according to Pew. Now that one major bank has stepped forward after regulatory guidelines were clarified, there is new potential for banks to compete with payday lenders and for consumers to get low-cost access to short-term loans.

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