Connecting With Payday Borrowers

Since their earliest days, credit unions have existed to serve people usually overlooked by big banks and targeted by predatory lenders.

The rise of payday lending in the 1990s challenged credit unions’ role, using a business model that combined a keen understanding of their customers’ vulnerabilities, a sophisticated army of state capital lobbyists and a deceptively simple product.

The result has been that despite attempts by consumer advocates and regulators to curb their practices, about 12 million Americans a year were taking out payday loans as recently as 2016.

These loans often carry interest rates of 390% or more, must be paid back within two weeks, and can trap borrowers in a cycle of debt.

This fact raises the central question that all consumer advocates need to answer, said Alex Horowitz, a researcher with the Consumer Finance Project of The Pew Charitable Trusts:

“If all these people have an account at a bank or credit union, why aren’t they borrowing from them?”

The NCUA started its Payday Alternative Loan program in 2010, but as of Sept. 30, 2018, only 494 of the nation’s 3,421 federal credit unions held PAL loans. Last May the NCUA proposed creating an additional PAL II program with higher loan limits and standards designed to make it easier for credit unions to offer the loans.

One of the issues has been its 28% limit on interest rates. Credit unions, non-profits and banks that are trying to offer fair, but sustainable programs said they need to charge rates as high as 120%.

The Filene Research Institute, the credit union non-profit think tank in Madison, Wis., is continuing to study innovative ways that credit unions are making small-dollar loans.

Filene, with support from VISA, is conducting a series of in-depth consumer interviews with people who used two services through its recent incubator program. It plans to complete interviews this summer with five members of Freedom First Credit Union of Roanoke, Va., ($600.9 million in assets, 52,334 members) regarding payday payoff loans and five members of Washington State Employees Credit Union of Olympia ($3 billion in assets, 274,254 members) regarding a program WSECU launched called QCash Small-Dollar Loans.

Ben Morales, CEO of QCash and chief technology and operations officer for WSECU, said credit unions hesitate to offer small-dollar loans because of:

• Regulatory uncertainty;
• Threat to image – they fear they will be perceived as a predatory lender, with Morales stating, “It becomes a brand issue;” and
• Financial stability – can they charge enough so the program pays for itself?

QCash, a wholly-owned CUSO of WSECU, offers a platform that credit unions can configure with whatever pricing and other controls they choose. About a dozen credit unions, including four federal credit unions with about 1.6 million members in 12 states, are now using QCash.

QCash loans through WSECU can be for $700 to $4,000 with terms ranging from nine to 36 months. A typical loan is about $1,400 for 12 to 14 months with an APR of 36% to 37%, Morales said.

U.S. Bank last September rolled out a small-dollar loan with fees more affordable to borrowers. For example, a $400 three-month loan will cost about $48 in fees, which comes out to a 71% APR.

“They’re setting the standard,” Morales said.

In St. Louis, Mo., another model is being explored. St. Louis Community Credit Union ($282.2 million in assets, 60,058 members) started an independent non-profit that in 2016 started offering small-dollar loans through strip mall storefronts called RedDough Money Centers. Those loans carry an APR of 120%.

Adam Lee, Filene’s incubator director, said one of the biggest barriers is the hesitancy of some credit unions to charge higher interest rates to the poor when they represent a higher risk. Filene’s position is that these programs can be sustainable and sound without being predatory. Protections typically include limiting payments to 5% to 6% of gross income, allowing longer payback periods and limiting repeat loans.

“Serving low-income or financially vulnerable populations does not have to be charity,” Lee said. “It can be a profitable enterprise for the credit union, if managed appropriately, just like any program.”

A credit union might have to charge a high APR for some payday payoff loans, but Lee said it will be better than rates from predatory lenders.

Lee said credit unions also need to pierce the myths about who uses small loans. Among most of their members, at some point in their lives they will have a period of financial crisis. “If they don’t think this is their core membership, I think they should look again.”

Horowitz said borrowers typically make about $30,000 per year, and have to manage their cash flow with the precision of a pilot flying at tree-top level.

“They’re living very close to the edge,” Horowitz said. “They don’t have much margin for error. If they run an overdraft fee for $35 that would be a real setback.”

St. Louis Community began offering a small-dollar lending program in 2007, but it was limited to people who had been members for at least 60 days. In 2009 it helped form Prosperity Connection, an independent 501(c)(3) nonprofit created to take on projects that might not be allowed by the credit union’s charter, or that were outside its expertise.

Prosperity Connection began by offering financial counseling through its Excel Centers. It then decided to take on payday lenders head-on by mimicking parts of their business model.

Borrowers go to payday lenders because they need money fast, and know they can get that money fast with few questions.

Prosperity Connection began consulting with the Pew Charitable Trusts and others to find a way to meet that need responsibly, without imposing judgment and with a pricing strategy that would allow the program to be sustainable.

Prosperity Connection’s solution was the RedDough Money Center. Like payday lenders, it uses small, brightly colored stores in small strip shopping centers. The first RedDough stores opened in 2016 and 2017, and were placed beside one of its Excel Centers and a St. Louis Community branch.

The grouping allows cross-referencing, according to Paul Woodruff, executive director of Prosperity Connection/RedDough and vice president of community development for St. Louis Community.

Some people who don’t meet the underwriting criteria for a loan at the credit union are referred to RedDough, and people applying at RedDough who qualify for a better deal through the credit union are referred there, Woodruff said.

People visiting the RedDough store are not required to enroll in financial counseling, but it is easily available, he said.

RedDough’s lending range is $100 to $1,000. Its average loan is $650 to $675 for six to 12 months. A $700 loan paid back over nine months carries $394 in fees and interest for a 120% APR, which Woodruff said compares with a 460% APR on a comparable payday loan in the area.

The triple-digit APR is objectionable to some in the credit union movement, but Woodruff said it was necessary to ensure that the program could serve a wide swath of the population needing small-dollar loans without creating a program that would collapse from losses.

“We had to be sure we could provide a sustainable service,” Woodruff said.

Credit unions need to be sure that their small dollar lending leaves members in better financial shape than when they started, said Cathie Mahon, president/CEO of Inclusiv, which was called the National Federation of Community Development Credit Unions until a name change last October.

The interest load needs to be as light as possible, and the lenders need to be sure that their borrowers can reasonably be expected to pay back the loans.

Some of those resorting to payday loans are doing so because of society’s failure to provide affordable health care and safety nets for those facing hardships. But credit unions should be trying to help those who need a cash infusion and who can repay an appropriate amount on fair terms.

“We all have to be careful,” Mahon said. “It’s very easy to see the need in your community and want to respond. On the other hand, you know you can’t suffer losses or offer too high of a cost product.”