Credit cards often grab the headlines, but rates are highly regulated, the market is transparent, and competition is stiff. Standard regulations like Reg E and Reg Z ensure a fair lending environment, and regulators like the OCC are there to ensure safe and sound lending. However, for those who maxed out their plastics, or are unable to qualify under bank underwriting standards, PayDay loans can be the only option.
I tried a couple of vendors a few years ago so I could experience the process, and perhaps feel the pain of sky-high interest rates. Call it crazy, but the field test is a good way to understand the business process. And perhaps be the first consumer to read the required disclosures from end-to-end. I did the same with BNPL, and a few non-national credit card companies just out of curiosity or simply professional interest.
The terms for the PayDay loan were notable. At this lender, borrowing $300 for 14 days incurs a $33 finance charge. Certainly, $33 will not kill a household budget, but the annualized interest rate is enough to bring shock to a frugal consumer.
Were you in a household that had a sick child, broken transmission, or inflight bank overdraft pending, the PayDay loan could be a lifesaver if there was no other option. In the experiment, I found the location to resemble a progressive bank branch and the people friendly. The transaction was settled in a matter of moments based on my 30-year-old checking account and a current paystub.
Recent state legislation helped with some of the usurious lending rates, but research by Pew Charitable Trusts points out a new trend. In a recently published study, they found that some banks are now charging more interest than PayDay lending. The article points out the excellent work addressing the credit-invisible market by Bank of America, U.S. Bank, and Huntington Bank, and it brings to light an interesting trend used by PayDay lenders who align with Utah’s quirky industrial banking laws.
According to the Utah Department of Financial Institutions, “industrial banks were also known as industrial loan corporations (ILCs) in Utah until 2004 when state law was amended to rename this class of institution to better reflect their legal status as fully-fledged FDIC insured depository institutions.”
A fledgling trend is the use of rent-a-bank licensing by local PayDay lenders. What is interesting is how the rent-a-bank model allows a licensed state lender to circumvent state interest caps. This is allowable because of a long-ago decision that allows banks to export rates based on the maximum allowable interest rate in the state. This logic is what 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 moving their rates from 88% to 149% in the state of Ohio, and in Oregon from 154% to 262% APRs. No impact was evident in a few states, but other examples include the states of Hawaii, Oregon, and Washington, where rates moved to 184%, 262%, and 260% respectively.
For now, know that credit card rates do not even approach this lending niche, and that PayDay pricing is high because of the inherent lending risk. But either way, usurious interest rates such as these can only solve a temporary household issue. In the long haul, PayDay lending costs a lot more than traditional bank lending.
A full copy of the report can be found here.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
