Has a softer, sweeter payday loan happened?
Traditionally, payday lenders offset the high cost of short term loans with annual percentage rates of 400% or more. A late borrower finds himself on a conveyor belt of debt, paying only interest and renewing the loan over and over again. But a new generation of alternative lenders say they want to help customers make payments on time and build good credit, so borrowers can access cheaper loans down the road.
Some call themselves “socially responsible” lenders, claiming that they don’t even consider making money with the loans.
“We can take advantage of it, but it’s very slim,” says Jeff Zhou, co-founder of Fig Loans, a Houston-based startup that extends beyond Texas. “Every dollar we make is an extra dollar we have to take, and it’s hard for people who don’t make a lot of money.”
Instead, Fig Loans and other alternative lenders want to direct clients to other financial products, such as long-term loans and credit cards.
“We believe the solution is to get people into traditional financial services,” says Leslie Payne, head of social impact and corporate affairs for LendUp, a California-based online lender that currently offers loans. in 11 states. “The bridge is what is crucial. You have to bring them, then raise them.
Essentially, these products share many essential characteristics with payday loans: they are available to people with no credit or bad credit; they are fast, with funds distributed electronically within 15 minutes at night; loans are for small amounts, typically less than $ 500; and payments are due relatively quickly – usually within two weeks or four months.
One final critical similarity: While these lenders may try to drive the price down, these low dollar loans always carry very high interest rates, almost always starting at over 120% APR.
Alternative but still expensive
Critics of the payday loan industry are not entirely convinced that alternative lenders are better for consumers.
“Anyone making loans over 36% APR should be a huge wake-up call to stay away,” says Lauren Saunders, associate director of the National Consumer Law Center.
Cost of a $ 500 loan over four months *
|APR||Monthly payment||Total interest|
|36%||$ 134.51||$ 38.05|
|140%||$ 163.46||$ 153.85|
|240%||$ 193.14||$ 272.58|
|400%||$ 243.81||$ 475.24|
|* By annual percentage rate (APR), compounded monthly|
Lenders say that getting money quickly to people without good credit is inevitably expensive. But the exclusion of high-cost loans essentially prevents millions of people from accessing formal lines of credit and “pushes people into more dangerous products, like loan sharks,” Payne says.
Nick Bourke, director of the Small Dollar Loans project at The Pew Charitable Trusts, admits loans can be expensive to process, but says they should always be manageable and user-friendly, which he’s unsure of. have seen in the online lending space. , which is rife with “widespread fraud and abuse”.
“There are just a few very basic challenges that make high cost payday loans or installment loans very expensive to do in a friendly manner,” Bourke said.
A 2014 Pew survey found that one-third of borrowers had withdrawn funds without their permission, and about one-fifth had lost bank accounts due to payday activities. “The borrowers are very clear,” Bourke says. “They want more regulations, they want more affordable payments. … They want a reasonable time to repay the loan.
What do new lenders say to such reviews? They agree.
“We believe affordability is key,” says Ken Rees, CEO of
Elevate, whose Rise Loans allow borrowers to refinance at lower rates. “All of our products are reimbursed over time, according to a schedule that suits them. “
So how do these new lenders claim to put clients first? Here are some features they often have that traditional payday lenders typically don’t:
Traditional payday loans allow you to pay interest only, transferring the principal into a new loan the next payday. Loans from alternative lenders are designed to be repaid with the principal decreasing after each payment.
This means that responsible lenders should carefully consider a customer’s repayment capacity. Rees, from Elevate, says, “We have to have affordability calculations because if a client is not able to repay that loan, we have to cancel it. “
If implemented, the new guidelines from the Consumer Financial Protection Bureau would require traditional payday lenders to screen borrowers using affordability tests.
Flexible or longer payment plans
Many alternative loans start with a repayment period of four months instead of two weeks or one month. “Having three, four or five paychecks to repay is what allows people to restructure their finances and move forward,” says Payne of LendUp.
The 2014 Pew Inquiry found that nearly a third of people who borrowed from traditional online payday lenders said they had received threats from those lenders, including threats of arrest by police. Such threats are illegal.
On the other hand, if customers can’t make a loan repayment, lenders like Rise say they prefer to reschedule. If customers don’t pay after 60 days, Rise “just charges it,” Rees says, though the default is reported to the credit bureaus.
“As a business, we are leaving a lot of money on the table by not imposing additional fees and by having more aggressive collection practices,” Rees said. “But that’s just how we did it. We think this fits really well with what [consumer regulators] are trying to do.
The promise of lower interest rates
The CFPB does not regulate interest rates. States are doing it. This means that rates can vary wildly from lender to lender and state to state.
In Texas, Fig Loans offers start-up loans at 140% APR. Rise and Oportun, a storefront lender in six states, say their rates are on average about half the cost or less of traditional payday lenders, which are typically around 400% APR, according to the CFPB.
In some states, however, the rates of alternative lenders can seem as scary as those of traditional payday lenders. Even so, borrowers may find that if they make payments on time, they will have the opportunity to lower these rates.
Rise says he will refinance his clients’ loans and bring them to 36% APR within three years, often less, according to Rees, “which is still expensive by blue chip standards, but for subprime borrowers, it is transformative “.
LendUp claims that customers who accumulate points on its loan ladder can potentially qualify for loans below 36% APR, “and this is something that is simply not available anywhere for the vast majority of our customers. “, says Payne.
A credit history and the resulting credit scores are essential for affordable borrowing. Traditional lenders who lend at rates of 36% APR or less typically require scores of 600 or more.
Most borrowers who turn to payday loans either have no credit history or have such a tarnished one that they do not qualify elsewhere.
Traditional payday lenders do not report payments on time to TransUnion, Experian, or Equifax, the major credit bureaus. A selling point for alternative lenders is that they report to bureaus – sometimes automatically, sometimes as an option.
Oportun, who has been using this model since 2005, reports that after three loans, his typical borrower achieves a credit score of 672, which is about average.
Unlike most quick loan stores, alternative lenders offer customers free online courses on budgeting, savings, and financial literacy. LendUp even rewards those who take courses with points to help them get better loan terms. “It’s another signal that these customers are less risky,” says Payne of LendUp.
Three-digit APRs are always three-digit APRs
While the smoother repayment practices and credit reports are well-intentioned, they don’t make these loans a good deal, experts say.
“High cost loans are still dangerous loans,” says Liz Weston, NerdWallet columnist and author of “Your Credit Score”. “There are much better ways to deal with a cash shortage and build your credit than taking a loan with triple-digit interest rates. “
Financial advisers point out that there are many non-traditional alternatives for quick cash that are not based on credit scores, such as community assistance programs, pawn shops, bill forbearance programs. , employer’s payday advances or loans against personal retirement or life insurance funds.
Any alternative that gives the borrower time to build credit through traditional means – a secured credit loan or card, one year of on-time payments on existing debts – can put a lower, more affordable loan at their fingertips. at 36% APR.
If you need instant cash, a lender who reports payments on time to the credit bureaus is probably a better choice than another, says Weston. But if you need another loan after the first one is paid off, check with a traditional bad credit lender to see if your scores have improved enough to qualify for a loan below 36% APR. , she says.
Alternative lenders recognize that extremely high interest loans like theirs are not the optimal way to get credit.
“We want people to take out these traditional loans,” says Zhou, who modeled Fig loans largely on the advice of nonprofits and financial coaches. “But there are situations where a financial coach may have to refer someone to a payday lender, and as a last resort we just say come to Fig instead of a payday lender.”
NerdWallet has no business relationship with any of the lenders presented.
This article originally appeared on NerdWallet.