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Payday-type loans expanding into mainstream

ALBUQUERQUE, N.M. — Payday loans, widely viewed as a pariah in lending, have gone mainstream with even that most consumer-friendly of financial institutions, the nonprofit credit union, routinely offering a version of them in New Mexico.

The need for emergency credit, which is the essence of a short-term, low-dollar payday loan, can be common among consumers living paycheck to paycheck. All it takes is a car breakdown or medical emergency.

“Maybe you would never dream of paying an annual percentage rate of 400 percent on a credit card or any other type of loan, but you might do it for a payday loan,” Richard Cordray, director of the federal Consumer Financial Protection Bureau, told a January hearing on payday lending in Birmingham, Ala.

“When you’re desperate, the terms of the loan seem to matter a lot less,” he said. “You need money. You need it now.”

Enter the credit union, whose motto is “Not for profit, not for charity, but for service.”

Emergency financing has long been available from credit unions in the form of automatic coverage of overdrafts in checking accounts. The effect of overdraft coverage is to provide a temporary safety net to members paying expenses greater than their account balance.

But true payday loans have been a conundrum for credit unions for reasons that boil down to risk and reward.

Payday loans are unsecured and don’t require a credit score, thus making them the kind of high-risk lending that credit unions have traditionally avoided. At the same time, the idea of charging high interest rates to cover the risk runs counter to the credit union business model, even if they could.

Interest rates on most if not all credit union loans are capped at an annual percentage rate or APR of 18 percent, which compares to annual interest rates of 200 percent and higher from conventional payday lenders.

A year-and-a-half ago after much deliberation, the National Credit Union Administration enacted a new lending rule specific to “short-term, small-amount loans” designed to be an alternative to conventional payday loans.

The most eye-catching part of the rule was allowing credit unions to charge an annual interest rate of up to 28 percent on these so-called “small loans.” About 400 credit unions, or about 5 percent of the roughly 7,500 nationwide, have offered payday-like loans with interest rates up to 28 percent.

Few credit unions in New Mexico appear to have exceeded the standard 18 percent cap on annual interest rates on their emergency loans.

“We’re out to help our members, not scalp them,” said James Raquet of U.S. New Mexico Federal Credit Union in Albuquerque, which offers a short-term, small-amount loan called an Eagle Advance at 18 percent annual interest.

Four Corners Federal Credit Union in Kirtland has offered a payday-type loan called the Payday Advance Loan or PAL since 2005 and its program has served as a model for similar programs around the country.

The loan limit is $700, payable in four months at an annual interest rat of 18 percent, for members who have direct deposit and have held their current job for at least six months. Members can take out only one PAL at a time, which is a requirement adopted by the NCUA in its October 2010 rule.

Losses from the PAL program at Four Corners FCU are minuscule, only about $100,000 in write-offs on more than $14 million in loans made through the program since 2005, according to CEO Phyllis Crawford.

Crawford attributed the low level of write-offs to Four Corners FCU’s closed membership, which is limited to workers and their extended families at six employers in the area, and the fact that 85 percent of its members are Native Americans.

“We know our members. We cater to their needs,” she said. “If you treat them right and they trust you, they’ll stay with you.”

New Mexico Energy Federal Credit Union, whose membership is restricted to workers at the Department of Energy and National Nuclear Security Administration, offers a six-month unsecured emergency loan at a 12 percent annual interest rate. The loan limit is $10,000, thus putting it outside the small-amount criterion of a payday-type loan.

“That’s in case the government shuts down,” said CEO Kathy L. Cranage. “We’ve never made one but we want to have it there.”

For the most part, unsecured emergency loans at credit unions appear to be for terms longer than six months, thus they do not meet the short-term criterion of a payday-type loan. The intent of these loans, however, is to serve as an alternative to conventional payday loans.

The biggest difference between emergency loans from a credit union and a conventional payday lender occurs when the borrower fails to pay off the loan on schedule.

With a credit union, the borrower is in default on the loan. The NCUA’s October 2010 rule prohibits small loan rollovers. Some credit unions will extend terms of the loan to allow the borrower more time to repay, without adding more fees, as well as provide credit and budget counseling to the borrower.

With a conventional payday lender, the borrower’s loan rolls over and resets at the original terms. The rollovers can continue until the loan is paid off or goes into debt collection.

Here’s a typical scenario painted by the Consumer Financial Protection Bureau:

A borrower takes out a payday loan with a two-week term, paying a $15 fee on each $100 borrowed. The fee can be interpreted as a 15 percent interest rate for two weeks, which translates to an APR of 391 percent.

If the borrower is unable to pay off the loan at the end of two weeks, then he or she pays another $15 fee on each $100 borrowed and the loan rolls over or renews for another two weeks. For practical purposes, the interest rate has grown to 30 percent on what has become a four-week loan.

Five more renewals later – 3 1/2 months from the date of the original loan – and the borrower has paid more in fees or interest payments than the principal amount of the original loan.

Scenarios like the one described above are the flashpoint for criticism of payday lenders for predatory lending practices, but the payday industry claims such scenarios are rare.

“Ninety-five percent of payday loans are repaid when due, a fact confirmed by numerous state regulatory reports,” says Alexandria, Va.-based Community Financial Services Association of America, trade organization for the payday industry, on its website.

The industry’s claim aside, the Consumer Financial Protection Bureau began earlier this year to conduct field examinations at banks and payday lenders to see how they conduct business. It’s a step in the direction of the first federal oversight of payday lenders.

“We recognize that there is a need and a demand in this country for emergency credit,” Cordray said at the January hearing. “At the same time, it’s important that these products actually help consumers and not harm them.”