Half of all online payday loan borrowers are hit with bank penalties averaging $185 when the automated payments on their loans fail or cause an overdraft, according to a report released by the Consumer Financial Protection Bureau.
More than one-third of borrowers with failed payments eventually lose their bank accounts, the CFPB says.
Online payday or installment loans are short-term, high-interest loans granted to borrowers without a traditional credit check. Some must be repaid in a lump sum after a week or two, and others may be repaid in installments over several months or years.
The CFPB examined nearly 20,000 bank accounts making payments to 332 of these lenders over an 18-month period from 2011 to 2012. The lenders typically use an electronic funds transfer system to deposit the loan directly into the consumer’s checking account, then use the same mechanism to withdraw the money owed come payday.
“Payday lenders promise instant cash, but since they don’t check your credit, these loans can have interest rates as high as 1,000%,” says Amrita Jayakumar, a NerdWallet writer who specializes in personal loans. “When you’re hit with bank fees on top of high interest, it’s even easier to get trapped in a cycle of debt.”
‘Collateral damage’ from repeated payment attempts
When lenders attempt to debit payments from accounts with insufficient funds, the borrowers face overdraft or insufficient funds fees.
Lenders often make multiple attempts to debit the account in the same day, the CFPB found, and sometimes try to retrieve a payment in multiple chunks to increase the likelihood that the borrower can repay at least part of the loan. Each failed attempt can result in high fees in quick succession for the borrower; the typical bank penalty for each overdraft or insufficient funds notice is about $35.
The likelihood of successful payment falls with each succeeding request, the CFPB said. The first attempt typically nets lenders $152, the second $53, and the fifth just $21, data showed.
In addition, lenders themselves may charge penalties for failed payments, which can range from a flat fee of $25 to a percentage of the outstanding balance, levied daily.
Of the borrowers who were hit with a bank penalty, 36% ended up involuntarily losing their bank accounts, usually within 90 days of the first failed transaction. Involuntarily losing a checking account at a bank or credit union can leave customers blacklisted from getting another such account in the near future.
“Taking out an online payday loan can result in collateral damage to a consumer’s bank account,” former CFPB Director Richard Cordray said at the time of the report. “Bank penalty fees and account closures are a significant and hidden cost to these products.”
The fees are bad; the loan is worse
The CFPB, which has authority over the payday loan and payday installment loan markets, is considering a proposal that would block payday lenders from making more than two unsuccessful attempts in a row on a borrower’s checking or savings account. A ruling is expected this spring.
Borrowers with bad credit already face steep odds, Jayakumar says, even without the added burden of bank penalties. In order to get a loan with terms generally considered consumer-friendly — that is, interest rates of 36% or less — borrowers face a traditional check of their credit reports and credit scores. Borrowers’ debt-to-income ratios are also a key factor in approval.
She suggests borrowers investigate more traditional sources of small-dollar loans, such as credit unions and online lenders that check credit. Some accept credit scores below 600.
The difference between the two types of loans is stark: A $2,000, two-year loan even at 36% APR would have monthly payments of $119, Jayakumar notes. At 200% APR, a conservative rate for an online payday installment loan, the payments would be $341.