Payday lenders have opened shop online — and that's created a new set of problems for borrowers, according to a report from the Consumer Financial Protection Bureau (CFPB).
Online lending offers the convenience and privacy that cannot be matched by a storefront operation. That's why customers are moving to the Internet. The CFPB estimates that about half the market for these small "cash advance" or "check loans" is now done digitally.
The bureau analyzed 18 months of data (2011-2012) on more than 330 online lenders and found that there can be serious consequences for those who cannot pay back their loans on time.
"Taking out an online payday loan can result in collateral damage to a consumer's bank account," said CFPB director Richard Cordray. "Bank penalty fees and account closures are a significant and hidden cost to these products."
Internet lenders challenge the CFPB's findings, pointing out that they're based on old data.
"In the fast-moving world of Internet lending, five years is an eternity, which is why many of the findings in this report are out of date," said Lisa McGreevy, president and CEO of the Online Lenders Alliance (OLA) in a statement."We believe that, if the CFPB had conducted its study using current data, there would have been a very different outcome."
Payday loans seem simple enough
For someone who lives paycheck to paycheck, a high-interest payday loan may be the only way to get quick cash. Payment in full is typically due on the borrower's next payday, but some payday lenders now offer longer-term installment loans.
Online lenders have direct access to their borrowers' checking accounts through the Automatic Clearing House (ACH) network. They use the network to electronically deposit the loan money, and then withdraw payments when they are due.
"Their easy means of collection means they have considerable power over a consumer's bank account," Cordray said during a telephone news briefing.
The trouble comes when the there's not enough money in the account to repay the loan — an all too common situation.
The CFPB found that half of all online payday loan borrowers have at least one debit attempt that overdrafts or fails. These accounts were charged an average of $185 in penalty fees during the 18 months studied.
If there's not enough money in the account to cover the payment, the bank can either make the payment and charge an overdraft fee, or deny payment and charge a nonsufficient funds (NSF) fee. If that happens, the payday lender may tack on a late fee, returned payment fee, or both.
But it doesn't stop there. If the initial request for payment fails, most lenders will try to collect again. Each attempt can result in even more fees. The CFPB found that in one extreme case a lender made 11 payment requests in a single day.
Some lenders will respond to a non-payment by splitting up the total amount into several smaller payment requests, and send them all on one day hoping to collect at least some of their money, according to the CFPB report. While one $300 payment request could result in one overdraft or NSF fee, three $100 requests could result in three penalty payments — about $34 each when this analysis was done.
Seventy percent of second payment requests to the same account fail, the CFPB found. Seventy-three percent of third payment requests fail. Each attempt after that is even less successful.
"Of course, lenders that are owed money are entitled to get paid back, but we do not want lenders to be abusing their preferential access to people's accounts," Cordray said. "Borrowers should not have to bear the unexpected burdens of being hit repeatedly with steep, hidden penalty fees that are tacked onto the cost of their existing loans."
Again, the online lending industry says the marketplace is not as bad as the CFPB report makes it seem.
"Bank account overdrafts are a lose-lose for online lenders and their customers," Lisa McGreevy with the Online Lenders Association (OLA) said in her statement. "Initiating a payment request against an account with insufficient funds doesn't help anyone: the lender does not get paid, and the consumer is hit with a $35 NSF fee by his or her bank."
McGreevy said new rules and OLA's best practices now prohibit splitting payments or resubmitting them on the same day.
A financial institution can close a checking account if it has a negative balance for too long or the customer racks up too many penalty fees.
Getting booted from your bank can have significant repercussions for someone who's already financially stressed. They may not be able to open an account at another bank or credit union, leaving them with no choice but to use expensive and time-consuming check-cashing and bill-paying services.
Rules expected soon
Consumer advocates have always criticized payday lenders for what they believe to be predatory and abusive practices.
"Like payday loans made by storefront lenders, online payday loans carry high interest rates, pull payments directly from a consumer's bank account and are made with little consideration of a borrower's ability to repay," said Tom Feltner, director of financial services at the Consumer Federation of America. "Payday loans result in long-term financial hardship and pile on overdraft and other fees that put borrowers' financial security at risk."
Last year, the CFPB announced that it was considering new rules to protect consumers from abusive payday loans.
The bureau is expected to propose prohibitions against payday lenders making more than two unsuccessful attempts in a row on a borrower's checking or savings account. It may also require payday lenders to consider a borrower's ability to repay the loan, as is standard practice for other loans
The proposed rules are expected to be released later this spring.
The Center for Responsible Lending (CRL) urged the CFPB to issue strong protections to prevent the "abusive payday lending practices" that keep millions of Americans "trapped in a vicious cycle of debt."
"The CFPB has the ability to stop this debt trap by requiring lenders to make sure the loan is affordable, by considering the borrower's income and expenses, to insure that loan can be repaid," said CRL's Diane Standaert. "All of America — including the working poor — deserves financial fairness."