Bank-Based Small-Dollar Loans: An Alternative to Payday Loans
Payday loans — your neighborhood loan shark in a retail box — have emerged as a hugely profitable underbelly to the banking business. Short-term loans with off-the-scale annual percentage rates that can exceed 500 percent are a growth industry in tough economic times; the industry raked in 42 billion dollars last year. Gary Rivlin, author of From Pawnshops to Poverty, Inc.: How the Working Poor Became Big Business, reports that the United States now supports more payday loan outlets than McDonald’s and Burger Kings combined. The FDIC would like to counter the trend with legitimate loan products designed to serve the “underbanked” lower income sector.
A recently concluded Small-Dollar Loan Pilot Program conducted by the FDIC featured loans that offered terms designed to beat those offered by payday sharks. Terms looked like this, according to the FDIC website:
|Amount||$2,500 or less|
|Term||90 days or more|
|Annual Percentage Rate (APR)||36 percent or less|
|Fees||Low or none; origination and other upfront fees plus interest charged equate to APR of 36 percent or less|
|Underwriting||Streamlined with proof of identity, address, and income, and a credit report to determine loan amount and repayment ability; loan decision within 24 hours|
|Optional Features||Mandatory savings and financial education|
The 2-year pilot program involving 28 banks expired in 2009. The trick now is to find a bank that will make a small-dollar loan based on this template. Big banks like Wells Fargo have not signed on to the program, preferring to stick with more lucrative — and less consumer-friendly — cash advance programs with APRs up to 120 percent.
Most small-dollar loans are for amounts in the range of $500 to $1,000 for periods of one year. Under the pilot program, banks used a small percentage of the loan proceeds to start a mandatory savings account that could not be accessed until the loan was nearly paid off. The idea behind this practice was to help the borrower start an emergency savings account to reduce the need for future loans.
To find a small-dollar bank lender in your area, check your local listings for small regional or community banks, ask for the loan desk, and request the loan profile using the information in the chart above. But if you can’t find a bank in your area that offers a small-dollar loan program, don’t be too surprised. Bank-originated small-dollar loans may be an idea whose time has not yet come.
FDIC Touts the Baltimore Model
FDIC staffers point with pride to a regional consortium of banks in Baltimore that joined forces with a nonprofit, Neighborhood Housing Services of Baltimore (NHS), to allow loan origination to be handled by the nonprofit instead of the banks.
“The interesting thing about this particular program is that it is a loan pool so several different institutions — credit unions, big banks, and small area banks are all partners in this program,” said FDIC staffer Joan Lok.
Eligibility for the Borrow and Save Program requires an income at or below 80 percent of the Area Median Income (AMI) and a pay stub. Other restrictions apply. Charles Martin, Regional CRA (Community Reinvestment Act) Manager at one of the participating banks, M&T Bank, calls the program “a successful pilot project” but says that in order for the program to catch on elsewhere, “It needs an experienced nonprofit partner and a wise regulatory partner.” He said the fact that NHS was already experienced at making loans was crucial to the success of the program.
Credit scores were not considered in the pilot program, but when asked if that would continue to be the case, Mr. Martin offered, “We’re looking at that.” In lieu of a reliance on credit scores the Baltimore model required borrowers to take a financial literacy class — a feature of the program considered essential by Mr. Martin.
Art Torres of Neighborhood Housing Services of Baltimore, said, “What we are really looking at is the payment histories, not the credit score per se. When we looked at clients who had run into problems, and looked at their credit scores, we found that the credit scores were not predictive of their performance.”
According to Luke Reynolds of the FDIC, the agency does not know how many banks have begun to offer the program. He pointed out that while the pilot program involved 28 banks, other banks offered similar programs under their own initiative. Of those that did participate in the pilot, “Overwhelmingly, the institutions said they were going to continue offering affordable small-dollar loans,” said Mr. Reynolds.
Credit Unions to the Rescue?
If you can’t find a bank that offers small-dollar loans, you might try your local credit union. The issue here is to find one you are eligible to join. One credit union, Diversified Credit Union of Minneapolis, Minnesota, offers a personal loan program that will make a one-year $1,000 loan with a top interest rate of 18 percent upon opening a new account with a savings deposit of $10 and no checking account requirement. “Due to state regulations, we can’t do anything over 18 percent,” said Dave Emmeck, a loan manager at Diversified, “most of these loans are from the 9.9 to the 12.9 percent range.”
Would-be borrowers must possess a credit score of 525 — admittedly low, but still better than some customers might have. And some young people have no credit score at all. According to Emmeck, people in a no- or low-score predicament can still get a loan if they can find a co-signer.
A Tentative Step in the Right Direction
Clearly, the FDIC pilot program was a step in the right direction and was by all observable measures a successful program, but whether or not widespread adoption of the model will follow is open to question.
Torres said, “For it to catch on the regulators are going to have to give CRA credit for these programs. Otherwise, the banks can make more money elsewhere.”
The Community Reinvestment Act was designed to encourage banks to meet the needs of all segments of their communities, particularly low-income customers. It is hard to see, for example, how Wells Fargo’s cash advance program, with an APR of 120 percent, boosts its CRA standing.
FDIC Chair Sheila Bair is on record in support of the small-dollar loan program, saying, "It is my hope that, over the next few years, responsibly priced small-dollar loans will become a staple offering among our nation's banks."
Hey, Wells Fargo and Bank of America, are you guys listening?
This is a guest post by Steve Klingaman, a nonprofit development consultant and nonfiction writer living in Minneapolis. Read more by Steve: