On the fringes and still an ugly business


Credit cards often make the headlines, but prices are highly regulated, the market is transparent, and competition is fierce. Standard regulations such as Reg E and Reg Z ensure a fair lending environment, and regulators such as the OCC are there to ensure safe and sound lending. However, for those who have maxed out their plastics or are unable to qualify by bank underwriting standards, payday loans may be the only option.

I tried a few providers a few years ago so I could experiment with the process and maybe feel the pain of sky-high interest rates. Call it crazy, but field testing is a good way to understand the business process. And maybe be the first consumer to read the required information cover to cover. I did the same with the BNPL and a few non-domestic credit card companies out of curiosity or just professional interest.

The terms of the payday loan were notable. At this lender, borrowing $300 for 14 days incurs a finance charge of $33. Granted, $33 won’t kill a household’s budget, but the annualized interest rate is enough to shock a frugal consumer.

If you were part of a household that had a sick child, an interrupted transmission, or an outstanding bank overdraft, the payday loan could save your life if there were no other option. In the experience, I found the location to be like a progressive bank branch and the people to be friendly. The transaction was settled in moments based on my 30 year old checking account and a current pay stub.

Recent state legislation has contributed to some of the loan sharking rates, but research from Pew Charitable Trusts indicates a new trend. In a recently published study, they found that some banks now charge more interest than payday loans. The article highlights the great work done by Bank of America, US Bank, and Huntington Bank in the dark market for credit, and highlights an interesting trend used by payday lenders that align themselves with the original industrial banking laws of Utah.

According to the Utah Department of Financial Institutions, “Industrial banks were also known as industrial loan companies (ILCs) in Utah until 2004, when state law was changed to rename this category of institutions to better reflect their legal status as full-fledged FDIC-insured depository institutions”.

An emerging trend is the use of bank lease licenses by local PayDay lenders. What’s interesting is how the bank lease model allows a state-licensed lender to bypass state interest caps. This is allowed due to a decision made long ago that allows banks to export rates based on the maximum interest rate allowed in the state. It’s this logic that put Citi’s card business on the map with its move to South Dakota.

However, in the context of payday loans and interstate rate migration, this is an example of interest rates on steroids. Pew cites examples of licensed payday lenders dropping rates from 88% to 149% in Ohio State and Oregon from 154% to 262% APR. No impact was evident in a few states, but other examples include the states of Hawaii, Oregon and Washington, where rates rose to 184%, 262% and 260% respectively.

For now, be aware that credit card rates don’t even come close to this lending niche and PayDay pricing is high due to inherent lending risk. But in any case, usurious interest rates like these can only solve a temporary household problem. In the long term, payday loans cost significantly more than traditional bank loans.

A full copy of the report is available here.

Preview by Brian RileyDirector, Credit Advisory Services at Groupe Conseil Mercator


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