Low-income communities that turn to nontraditional banking products stand to see outrageous fees and interest rates reined in.
This week's credit check: 17 million Americans are unbanked. Using nonbank products can lead to over $1,100 in fees a year.
As part of its mandate, the Consumer Financial Protection Bureau will begin policing both the big banks and the shadowy world of nonbanks. That latter category will include firms like payday lenders, debt collectors, and check cashers that have gone without much oversight. The Bureau just announced that it plans to oversee six new areas -- debt collection, consumer reporting, consumer credit, money transmitting and check cashing, prepaid cards, and debt relief services -- and will be cracking down on a host of other predatory products.
This is fantastic news for all consumers. I've previously written about the aggressive debt collection agency tactics that have been ramped up in the aftermath of the financial crisis, including putting people in jail. Consumer reporting -- companies in charge of credit reports -- aren't much better. Not only do many reports contain errors, it's very difficult to correct them. Both have escaped intense scrutiny, but that's about to change.
A crackdown in nonbank lending will particularly benefit lower income people and the unbanked. About 17 million Americans are considered unbanked, meaning they don't have a bank account or a relationship with another mainstream institution. Another 21 million are "underbanked" -- they have checking accounts but still often turn to nonbank services like payday lenders and check cashers. Some of these people are turned off by mainstream banking products, but many just can't afford the service charges and fees. Yet others find that their neighborhood offers few other options.
Payday lenders are one of the most expensive products marketed to the unbanked. They target people with paychecks, but unemployment checks also count -- so business is soaring. They work as a short-term loan to be paid back when the borrower gets that check. And part of why it's such a lucrative business is that the interest rates can be outrageous. When annualized, they can reach 450%. That figure doesn't even include the fees, which can be an upright hit of $45. With such a shoddy deal, you would think that these products are used as a one-time solution. But as Brad Tuttle reports, consumers often get stuck in a "vicious cycle":
First, the customer borrows to cover a financial shortfall. He pays off that loan soon after receiving a paycheck, but in the course of paying off the loan and its substantial interest, that puts the customer in a tough spot the month after the initial loan. So how does he pay the bills? By taking out another payday loan. Lather, rinse, repeat. If a borrower is late paying back a payday loan, fees kick in, making that loan harder to pay off-and increasing the chances of another financial shortfall down the line.
Check cashers may not be quite as outrageous as payday lenders, but they're not much better. The New York Times reports, "Most cashers pocket between 2 and 4 percent of each check's value, which a recent Brookings Institution study calculated could add up to $40,000 in fees over a customer's working life."
These lenders aren't equal opportunity predators, either. They tend to target low-income people and communities of color. In fact, "[i]n these communities of color payday lenders are three times as concentrated as compared to other neighborhoods," according to a report by National People's Action. This trend is being exacerbated in the recession, as traditional banks close up shop in these areas to open their doors in wealthier ones. The New York Times reports:
In low-income areas, where the median household income was below $25,000, and in moderate-income areas, where the medium household income was between $25,000 and $50,000, the number of branches declined by 396 between 2008 and 2010. In neighborhoods where household income was above $100,000, by contrast, 82 branches were added during the same period.
As Mark T. Williams, a former bank examiner for the Federal Reserve, observes, "When a branch gets pulled out of a low- or moderate-income neighborhood, it's not as if those needs go away." They get filled by payday lenders and check cashers, who can then reap fees and interest off of these underserved communities.
Prepaid debit cards are another nonbank product that these communities can tap into, and they can be cheaper to use than payday lenders. While they're being marketed to young tweens -- a card with the faces of the Kardashian sisters was set to go to market until Connecticut AG Richard Blumenthal threatened to put the kibosh on it -- and those who have a distaste for credit cards, they're also seen as a way to get money to underserved communities, particularly the poor and the unbanked. An expected $37 billion will be loaded onto prepaid cards this year, and the total market is expected to double in size in the next three years, with an $672 billion loaded onto these cards by 2013. But as Adam Levitin notes, "prepaid debit products are often as predatory in their pricing as check-cashing outlets."
In search of evidence of that claim, Candice Choi, a reporter for the AP, spent a month without her bank and ended up racking up $93 in fees total, including $4.95 to buy a prepaid debit card upfront and $1 per swipe of the card, which would work out to $1,100 a year "just to spend my own money," as she puts it. The fees charged by these cards vary wildly, in part because there's been no oversight of the industry. A consumer can be charged for activities ranging from account activation and cash withdrawal to simply not using the card. Lack of oversight also means that they usually aren't under federal protections, including fraud and FDIC insurance. And last but not least, not only do fees vary widely, but their disclosure does as well. A report from AARP warns, "The lack of clear and concise disclosure of all fees associated with a [prepaid debit card] can result in consumers incurring fees that will rapidly drain their account balance."
For too long these industries have existed like vampires: sticking to the shadows and living off other people's welfare. But the Consumer Financial Protection Bureau is promising to shine some much needed sunlight on their activities. That will be a big win for all consumers -- and particularly for the unbanked.
Bryce Covert is Assistant Editor at New Deal 2.0.