The Great Debate

Servicing the underbanked

A new report from the United States Postal Service inspector general proposes that the agency offer non-bank financial services, including payday loans. Opinion pieces and blog posts praised this idea as a way for the post office to solve its fiscal woes while reaching a portion of Americans outside the traditional banking system. A Reuters “Great Debate” piece, “Transforming Post Offices into banks”), called the proposal a “win-win.”

These pieces overlook some practical problems, however, and leave numerous questions unanswered about implementation. While government and charitable-sponsored financial services should play a role in consumer lending, they cannot replace market-based solutions.

Notably, the USPS proposal underestimates the challenge of offering consumer financial services in an increasingly competitive marketplace regulated by complex federal and state laws. Without a sizable government subsidy, the report’s suggested interest rate for small-dollar loans would not even cover basic operating expenses.

A number of credit unions, community banks and nonprofit organizations have started similar, artificially low-priced, small-dollar loan programs only to struggle to sustain operations, much less make a profit. This has led many institutions — credit unions in particular — to conclude they cannot viably provide short-term credit, according to research by University of California, Davis Professor Victor Stango.

Local storefront lenders can offer market-competitive prices — with rapidly diversifying portfolios, insights from data on consumer trends and operational efficiencies — to meet the growing demand for short-term loans and other non-bank financial services.

Key is holding a job, not just getting one

In these hard times, many people believe the solution to our nation’s economic ills can be summed up in one word – jobs. But that’s just the start. A stable economy can only exist when every family finds a place in the economic mainstream. Finding that place requires financial literacy.

Yet the basic financial skills much of the middle class learned as teenagers can be a foreign language to the working poor. Real economic inclusion takes savvy – knowing how to handle workplace challenges, stick to a budget, and build good credit. If middle-class and well-off Americans benefit from financial counsel, then why not the working poor?

Financial literacy matters. Far more than half of all Americans will slip in and out of poverty at least once in their lifetime. Struggling to make ends meet is harder when you don’t know the financial ropes. It means continuing to rely on costly, seat-of-the-pants solutions when money is tight – like payday loans and check-cashing outlets.

Don’t make payday loans a scapegoat

Credit access remains a challenge for millions of Americans, leaving them with limited options to meet their financial obligations. Payday loans are just one form of short-term, small-dollar credit that bridges this gap, ensuring access to cost-competitive, reliable and transparent credit when faced with periodic financial challenges. Unfortunately, this service is often misunderstood and misrepresented, as demonstrated by a recent “Great Debate” piece, “Is the payday loan business on the ropes?” (September 21, 2012).

Fifteen years ago, the payday lending industry emerged because of consumers’ need and demand for access to affordable small-dollar credit – credit that wasn’t readily available to many consumers or offered by many traditional financial institutions. Today, according to the Consumer Federation of America, nearly 40 percent of Americans live paycheck to paycheck, with less than a third feeling financially comfortable. The short-term-credit landscape has evolved over the years, as exemplified by the overwhelming popularity and rising cost of competing products like overdraft programs and bank deposit advances.

Advance America offers payday loans in its 2,400 centers around the country. Before choosing any lender, consumers should carefully weigh their options, including bank and credit union advances, overdraft and non-sufficient funds fees, and missed-payment and utility-reconnection charges. To help inform consumers’ choices, we disclose our one-time, flat fee – typically around $15 per $100 borrowed – as both a dollar amount and an implied annual percentage rate (APR). While most consumers make their credit decisions based on the real cost, we disclose the implied APR to help them compare products and make smart borrowing decisions. However, our loans do not accrue interest: Whether customers repay their loan in three days or 30 days, they pay the same fee. For many, a payday loan makes personal and economic sense – it may actually be their least-expensive option.

Is the payday loan business on the ropes?

Payday lenders have a lot in common with pawn shops, their close cousins: They depend on lending money to desperate people living close to the edge with nowhere else to turn. They first surfaced about 20 years ago in the South and Midwest, often as small mom-and-pop shops. Now the industry is dominated by large national chains, with some 20,000 storefronts nationwide. Coming out of the shadows of cyberspace, however, are Internet lenders, which are like storefront lenders on steroids.

The average payday loan is tiny, about $400, and in the benign view of the industry, it gives customers with trashed credit scores, who lack other credit options, emergency cash until their next paycheck arrives. But according to the Center for Responsible Lending, lenders charge a mind-boggling 391 to 521 percent interest for loans that have to be paid off in two weeks, often triggering a toxic cycle of debt, as borrowers take out fresh loans to cover the old ones. Internet loans are bigger, generally charge a higher annual percentage rate and, consequently, are more expensive than their storefront counterparts.

As non-banks, payday lenders have so far escaped federal regulation, leaving a hodgepodge of state laws as the only bulwark against these usurious loans. If the storefront lenders have been hard to regulate, Internet lenders have been even harder to find, as they make loans to lenders in states where they’re banned by setting up servers offshore or in states where they are legal. Industry experts put the number of online lenders in the hundreds, so far, but one website can reach many more people than a storefront. A January report from San Francisco-based JMP Securities estimated that market share for Internet lenders would hit 60 percent by 2016.

Good riddance to the tax refund loan

Tax season is full of familiar rituals – mounds of receipts on the kitchen table, midnight news reports from the post office and, of course, all those wacky come-ons from tax preparers promising easy money.

There are the Liberty Tax guys dancing at strip malls in Statue of Liberty costumes. The “FA$T CA$H” banners plastered on storefronts. And in a cult classic of advertising, all over the South there were those ridiculous Mo’ Money Taxes commercials in which buffoonish Southerners bumble through financial crises. Each one ends with advice on how to avoid a similar mess: “Just come on down to Mo’ Money!”

All of these campy promos are actually selling costly loans against your own money, but they have in fact generated lots of easy cash – for the lender, if not the borrower.

Refund anticipation loans, as they are called, have been risk-free business for most of the past decade. Lenders offer roughly 10-day advances of tax refunds, for which they charge exorbitant subprime fees. More than 12 million taxpayers got anticipation loans in their peak year, in 2004, according to the National Consumer Law Center. IRS data shows that over 90 percent of people who applied in 2010 were low-income.

Don’t be fooled, though, refund anticipation loans are no fringe market. Throughout the so-called boom years, the same banks that sit at the center of our high-end economy spread this fraud-ridden industry throughout its bottom tier. Take for instance Mo’ Money, which has faced several fraud probes. Until 2010, its storefronts were actually agents of JPMorgan Chase. The bank backed roughly 13,000 independent preparers in this business.